Chapter 6 Fixed-Income Securities: Features and Types RQ Flashcards
Why are Government of Canada Real Return bonds attractive to investors?
A. The interest payment and principal repayment are adjusted for inflation.
B. The principal repayment is adjusted for inflation.
C. Interest payments are adjusted for inflation.
D. Government of Canada bonds are the least risky of Canadian government securities.
A. The interest payment and principal repayment are adjusted for inflation.
Real Return bonds are attractive as a hedge against inflation. Both the interest payment and the principal repayment are calculated based on an inflation compensation calculation. Interest payments are determined as the real return multiplied by the bond value escalated for inflation. The maturity value is the original face value multiplied by the total amount of inflation since the issue date.
Hardeep wishes to invest in a GIC that will allow him to continue to contribute money each month towards this investment. What type of GIC would you recommend to him?
A. Escalating GIC.
B. Laddered GIC.
C. Deposit-linked GIC.
D. Instalment GIC.
D. Instalment GIC.
An Instalment GIC allows the investor to contribute towards the GIC each month.
Will a sinking fund or a purchase fund result in a greater proportion of a bond being retired early?
A. A purchase fund because retirements are mandatory.
B. A sinking fund because retirements are mandatory.
C. A purchase fund because the company has the right to call in bonds if needed to meet the requirements.
D. A sinking fund because the company only has to retire bonds during periods of rising interest rates, when bond prices are falling.
B. A sinking fund because retirements are mandatory.
A sinking fund will result in a greater proportion of an issue being retired because a specified amount of the bond must be redeemed each year. With a purchase fund, redemptions will only be made if the market price of the bond is at or below a specified price.
A bond quoted as trading at 98, but with a $1,000 par value, would mean that:
A. the bond is trading at a discount.
B. an investor would pay $980 minus any accrued interest for each bond.
C. the bond is trading at a premium.
D. an investor would pay $1,000 plus any accrued interest for each bond.
A. the bond is trading at a discount.
All bond prices are quoted based on an index with a base of 100. A bond trading at 100 is said to be trading at face value, or par. A bond trading below par, say at a price of 98, is said to be trading at a discount (the 98, based on the index of 100, indicates the bond is trading at 98% of par, or $980). A bond trading above par is said to be trading at a premium.
During what time period can Ngoc, who owns an extendible bond, decide to extend the maturity date of the bond?
A. The subscription period.
B. The accrual period.
C. The election period.
D. The extendible period.
C. The election period.
With both extendible and retractable bonds, the holder’s decision to exercise the maturity option must be made during the time period called the election period. This time period normally lasts for six months. In the case of an extendible bond, the election period normally occurs from one year to six months before the short maturity date. During this period, the bondholder must notify the appropriate trustee or agent of the debt issuer whether he wishes to extend the term of the bond or allow it to mature on the earlier date. If the holder takes no action, the bond automatically matures on the earlier date and interest payments cease. In the case of a retractable bond, the election period usually occurs from one year to six months before the earlier maturity date. If the retractable bondholder does not notify the appropriate trustee or agent of the debt issuer that they wish to exercise the retractable option during this period, the debt remains a longer-term issue.
The 5.25% ABC convertible bond is convertible into 50 shares of common stock for each $1,000 of face value. Identify the correct statement regarding the relationship between the convertible bond and the common stock.
A. If the common stock is currently trading at $20 a share, the ABC convertible is selling below its conversion value.
B. If the common stock is trading at $25 a share, the ABC convertible acts like a straight debenture.
C. If the common stock is trading at $20 a share, the premium on the ABC convertible will equal $52.50.
D. If the common stock is currently trading at $22 a share, the ABC convertible will rise to a value of at least $1,100.
D. If the common stock is currently trading at $22 a share, the ABC convertible will rise to a value of at least $1,100.
Market prices of convertible debentures are influenced by their investment value and by the price of the underlying common shares into which they can be converted. The conversion price of the ABC debenture is $20 a share. When the common shares of the issuing company trade well below the conversion price, the debenture acts like a straight debenture. When the common stock begins to trade above the conversion price, the value of the debenture begins to rise. When the ABC share price is $22, the value of the debenture rises to at least $1,100, for the following reason. If the stock increases in price to $22 per share, and an investor owns a $1,000 face value bond that can be converted into 50 shares, the investor could convert the bond and would now hold 50 shares worth $1,100 ($22 x 50). If, instead of converting the bond, the investor were to sell it to another buyer for only $1,000, that buyer could purchase the investor’s bond and then convert the bond into 50 shares worth a total value of $1,100. So it wouldn’t make sense for the investor to sell the bond for anything less than $1,100.
Identify the correct statement regarding a bond with a Moody’s rating of “A”?
A. They are judged to be the most superior in quality.
B. They are upper-medium grade.
C. They may possess certain speculative characteristics.
D. They are judged to be subject to substantial credit risk.
B. They are upper-medium grade.
Bonds with a Moody’s “A” rating are judged to be upper-medium grade and are subject to low credit risk.
What type of company would issue a collateral trust bond?
A. A holding company that does not have fixed assets, but owns securities of subsidiaries.
B. A company which has already issued significant amounts of other types of bonds and debentures.
C. A junior company with a low credit rating.
D. A company that holds significant levels of rolling stock, e.g., locomotives and train cars.
A. A holding company that does not have fixed assets, but owns securities of subsidiaries.
Collateral trust bonds are issued by holding companies. These companies usually do not own many fixed assets. They own securities in subsidiaries that can be pledged to secure bonds.
Why might Vladimir invest in a strip bond?
A. Vladimir requires a steady stream of cash.
B. Strips can be paid in installments over time.
C. Vladimir does not require cash until after the bond matures.
D. Strips are frequently lower quality with higher yields.
C. Vladimir does not require cash until after the bond matures.
A strip bond is created when a dealer acquires a block of high-quality bonds and separates the interest coupons from the principal. Each part is sold separately with the principal part known as a strip bond. It is attractive to investors who do not need immediate cash flow and who do not want reinvestment risk or hassle. If the investor were to receive interest payments, they must be invested and there is the risk that the reinvestment rate will be lower than current rates.
Select the statements regarding long-term debt that are correct.
Bonds are usually secured by real assets.
Subordinated debentures rank behind some other long-term debt security.
A collateral trust bond is usually secured by financial assets.
Corporate notes rank ahead of all other fixed-interest securities of the borrower.
A. 1 and 2.
B. 1, 2 and 3.
C. 1, 2 and 4.
D. 2, 3 and 4.
B. 1, 2 and 3.
A bond is secured by physical assets in a trust deed written into the bond contract. If the bond goes into default, the trust deed provisions allow certain specified physical assets to be seized by the bondholders and sold to recover their investment. These physical assets could be a building, a railway car, or something more exotic.
Subordinated debentures are debentures which are junior to some other security issued by the company or some other indebtedness assumed by the company. The exact status of an issue of subordinated debentures may be ascertained from the prospectus.
A collateral trust bond is one which is secured, not by a pledge of real property as in a mortgage bond, but by a pledge of securities, or collateral. Collateral trust bonds are issued by such companies as holding companies, which do not own much in the way of fixed assets on which they can offer a mortgage, but do own securities of subsidiaries. This method of securing bonds with other securities is similar to the common practice of pledging securities with a bank to secure a personal loan.
A corporate note is an unsecured promise made by a borrower to pay interest and repay the funds borrowed at a specific date or dates.
ABC Inc. has just received a higher credit rating from Moody’s Canada Inc. What impact will this have on its ability to raise funds?
A. ABC will have to pay a higher coupon rate on its new bonds as investors know it is a successful company.
B. ABC will have a harder time issuing equity as investors will expect a higher return.
C. ABC will be able to pay its bonds off faster as they can lower the coupon rate on their existing bonds.
D. ABC will be able to pay a lower coupon rate on its new bonds as it is seen as a more creditworthy company.
D. ABC will be able to pay a lower coupon rate on its new bonds as it is seen as a more creditworthy company.
A high rating provides benefits, such as the ability to set lower coupon rates on issues of new securities.
DDD Co. Inc. has an outstanding 12-year bond with a coupon of 8.75%. The financial press is quoting a yield of 6% for this bond. What does this imply?
A. Interest rates have gone up since the bond was first issued.
B. The company must have defaulted on a payment if the yield has gone down.
C. Interest rates have gone down since the bond was first issued.
D. It implies nothing, as yields naturally fall as time to maturity approaches.
C. Interest rates have gone down since the bond was first issued.
Interest rates have fallen as the yield is now below the coupon rate.
In November of the current year, Silpa has $10,000 to invest. She needs the full amount in one year. Select a suitable investment for her.
A. 90-day Treasury Bill.
B. 5-year Cashable GIC.
C. 5-year Index-linked GIC.
D. 5-year corporate Bond.
B. 5-year Cashable GIC.
Silpa can cash in the 5-year GIC after one year. A 5-year Index-linked GIC would lock her money in for 5 years. Corporate bonds are more volatile and less liquid. She may not be able to get her money back when she needs it. A 90-day Treasury Bill pays very little interest and she would have to decide where to invest her money in 90 days.
Natalie is concerned about the impact of inflation on her investments. She wishes to purchase an investment that shields her from the negative impact of rising prices. What security would you recommend to her?
A. Index-linked GIC.
B. 7-year GIC.
C. Real return bond.
D. Floating rate bond.
C. Real return bond.
The Government of Canada also issues real return bonds (RRB). A RRB resembles a conventional bond because it pays interest throughout the life of the bond and repays the original principal amount on maturity. Unlike conventional bonds, however, the coupon payments and principal repayment are adjusted for inflation. RRBs have a fixed real coupon rate.
Interest rates have been declining dramatically over the last two years. Identify the investment that would be most affected by this decline.
A. Floating Rate Bonds.
B. Strip Bonds.
C. Zero Coupon Bonds.
D. Government of Canada Bonds.
A. Floating Rate Bonds.
The disadvantage of floating rate bonds is that when interest rates fall, the interest payable on them is adjusted downwards at six-month intervals, so their yield tends to fall faster than that of most bonds. A minimum rate on the bonds can provide some protection to this process, although the minimum rate is normally relatively low. CSBs and government bonds have fixed rates, while strip bonds do not pay interest.
