Chapter 20

Question 1

Government Debt Securities

Answer 1

• Government of Canada fixed coupon/T-bills/real return bonds
• fed government security issues
• provincial t-bills or marketable bonds
• municipal

Question 2

Non-Government Debt Issues

Answer 2

• corporations
• asset backed securities
• foreign corporations and governments

Question 3

Eurobonds

Answer 3

issued in foreign markets and are denominated in currencies other than those of the markets in which they are issued

Question 4

Zero Coupon Bonds/Strip Bonds

Answer 4

no periodic coupon payments, interest compounds over time and is paid at maturity
Return is treated as regular interest income, not capital gain and investor must include all notional interest that accrued each year up to the anniversary date

Question 5

Call feature

Answer 5

issuer has the right to buy back the issue at specified times before the final maturity date

Question 6

Conversion option

Answer 6

allows the owner of the security to convert the debt obligation to another type of security (another debt security (exchangeable bond) or common shares (convertible bond))

Question 7

Ranking of corporate liabilities:

Answer 7

• First mortgage liabilities and asset backed securities
• Secured debt
• Unsecured debentures
• Capital securities
• Preferred shares
• Common shares

Question 8

T-Bills

Answer 8

Shortest term marketable debt instrument issued by governments

Question 9

Bankers Acceptance

Answer 9

Commercial draft drawn by a borrower for payment on a specified date and guaranteed at maturity by the borrowers bank (1 year or less)

Question 10

Commercial Paper

Answer 10

Unsecured promissory note issued by a corporation or backed by a pool of underlying financial assets in ABS form (up to one year)

Question 11

Debentures

Answer 11

legal contract with a claim to residual assets in case of bankruptcy

Question 12

Real Return Bonds

Answer 12

Resembles a conventional bond but coupon payments and principal repayment are adjusted for inflation

Question 13

Mortgage Backed Securities

Answer 13

Investment that represents ownership of the cash flows from a group of mortgages (usually 3-5 years and payments received on the 15th)

Question 14

Two NHA MBS Types:

Answer 14

 Open NHA MBS: clauses that permit the mortgagors to make early principal prepayments
 Closed NHA MBS: no early principal payments

Question 15

Commercial MBS

Answer 15

The underlying mortgages typically consist of several properties across Canada, with full disclosure available in the prospectus for each issue

Question 16

Asset Backed Securities

Answer 16

Debt securities secured by a pool of financial assets

Question 17

Issuer Extendible Notes

Answer 17

Debt instruments for which the issuer has the right at certain points (normally the anniversary date of issue) either to allow the bond to mature or to extend the maturity

Question 18

Capital Securities

Answer 18

Subordinated debentures that rank below all other indebtness of the issuer, but above that of all equity stakeholders

Question 19

Risks of Debt Securities: Credit Risk

Answer 19

Issuers ability to make timely payments of interest and principal

Question 20

Risks of Debt Securities: Interest Rate Risk

Answer 20

Interest rate risk is a risk for debt security’s not held until maturity since the price will change based on interest rates

Question 21

Risks of Debt Securities: Reinvestment Risk

Answer 21

Reinvestment risk is the risk that an investor cannot invest the coupon income at the bond’s yield to maturity so they will be forced to accept a lower yield

Question 22

Risks of Debt Securities: Timing Risk

Answer 22

Call option or prepayment option are disadvantages to the investor because CF is not certain

Question 23

Risks of Debt Securities: Yield curve Risk

Answer 23

Risk that changes in the shape of the yield curve will cause debt instruments of different maturity dates to change in value at different rates than originally expected

Question 24

Risks of Debt Securities: Marketability Risk

Answer 24

Marketability risk concerns the ease with which a debt security can be sold at or near its true value prior to maturity

Question 25

Risks of Debt Securities: Sector Risk

Answer 25

Debt securities in different sectors of the market respond differently to economic, financial, environmental, or interest rate changes relative to other sectors

Question 26

On-the-run instruments

Answer 26

are known as benchmarks and are more liquid issues

Question 27

Off the Run issues

Answer 27

not traded as frequently as the benchmarks and are therefore less liquid

Question 28

Price discovery

Answer 28

the pricing and placement of new issues in the primary market

Question 29

How does a cost center operate?

Answer 29

the retail trading desk is not set up to make profits in the market. The cost of maintaining a presence on the institutional trading floor is covered by the advisors’ commissions and fees withheld by the firm

Question 30

How does a profit center operate?

Answer 30

the retail desk buys inventory and offers it out with the intent of earning a profit so the trades cover its operating costs

Question 31

Three Shapes of Yield Curve:

Answer 31

• normal: short term interest rates are lower than long term
• flat: short term interest rates are the same or close to long term
• inverted: short term interest rates are greater than long term

Question 32

Yield Curve Parallel Shift

Answer 32

occurs when yield to all maturities move up or down by the same, or nearly the same amount

Question 33

Yield Curve Twist

Answer 33

occurs when yields toward one end of the yield curve move up or down by more than the other end

Question 34

Yield Curve Hump

Answer 34

occurs when the yield at a certain maturity moves up or down independently or in a greater amount than yields at all other maturities (rare)