Chapter 7: Corporate and US Govt Bonds Flashcards
What are the months with 31 days (7)?
- January
- March
- May
- July
- August
- October
- December
Which of the following bond certificates require the investor to turn in coupons in order to receive interest payments?
I. book entry bonds
II. fully registered bonds
III. bearer bonds
IV. partially registered bonds
A. I and III
B. III and IV
C. I, II, and IV
D. I, III, and IV
B. III and IV
A client purchased an ABC convertible mortgage bond at 105. Two years later, the bond is trading at 98. If the coupon rate of the bond is 6%, what is the current yield of the bond?
A. 5.7%
B. 6.0%
C. 6.1%
D. cannot be determined
C. 6.1%
CY = annual interest / market price
CY = $60 / $980 = 6.1%
A client purchased an 8% bond yielding 9 percent. He purchased the bond at
A. a discount
B. par
C. a premium
D. cannot be determined
A. a discount
Seesaw: Price – NY (8%) – CY - YTM (9%) - YTC
A client purchased a 6% corporate bond on Friday, October 21. The coupon dates are January 1 and July 1. How many days of accrued interest does the client owe?
A. 115
B. 117
C. 120
D. 122
A. 115
You have to begin your calculations from the settlement date (the date that the issuer records the new owner’s name). Corporate and municipal bonds settle in 3 business days. You’re thrown a curve ball because you have to contend with a weekend.
10/26 - 7/1 = 3/25 or 3 months (30 day months) and 25 days = 115 days of accrued interest
A client purchased a 5% T-bond on Monday, November 18. The coupon dates are January 1 and July 1. How many days of accrued interest does the client owe?
A. 135
B. 138
C. 141
D. 142
C. 141
You have to begin your calculations from the settlement date (the date that the issuer records the new owner’s name). Treasury bonds settle in 1 business day.
11/19 - 7/1 = 4 months (30 day months) + 18 days = 138 days + 3 days for July, August, and October = 141 days of accrued interest
An investor purchased a 6% ABC convertible bond. The bond is currently trading at 106, and the underlying stock is trading at 26. If the conversion price is 25, which of the following statements are TRUE?
I. the stock is trading above parity
II. the stock is trading below parity
III. converting the bond would be profitable
IV. converting the bond would not be profitable
A. I and III
B. I and IV
C. II and III
D. II and IV
D. II and IV
Conversion ratio = par value / conversion price
$1,000 / $25 = 40 shares
Parity price of the bond = market price of the stock * conversion ratio
$26 * 40 shares = $1,040
Because the value of the bond is greater than the converted value of the stock, the stock is trading below parity and converting wouldn’t be profitable.
A client purchased ABC convertible bond at 115 with a conversion of 25. If the common stock for ABC is currently $48 per share, when would the client convert his bond?
A. right away
B. when the common stock falls below $46 per share
C. when the common stock increases to $50 per share
D. never, because bonds are safer investments than stocks
A. right away
Always assume for test purposes that if the stock is trading above parity, the investor should convert.
Parity price of the bond = market price of the stock * conversion ratio
$48 * 25 shares = $1,200
The bond is currently trading at $1,150 (115 percent of $1,000 par) and is convertible into $1,200 worth of stock so it makes sense to convert.
A client would like to start saving for a newborn baby. He has $30,000 to invest and seems concerned about the safety of his investment. Which of the following bonds would you MOST likely recommend to help meet his goals.
A. AA-rated corporate bonds with 18 years until maturity
B. T-STRIPS with 18 years until maturity
C. T-bonds with 18 years until maturity
D. high yielding corporate bonds
B. T-STRIPS with 18 years until maturity
When you see a question about the best investment when planning for a future event, the right answer will likely be either zero coupon bonds or T-STRIPS.
Companion tranches support
I. PO tranches
II. PAC tranches
III. TAC tranches
IV. IO tranches
A. I only
B. II only
C. II and III
D. II, III, and IV
C. II and III
Companion tranches absorb the prepayment risk associated with CMO’s. All PAC and TAC (targeted amortization class) are supported by a companion tranch
________ tranches are usually the last tranche (they have the longest maturity) in a series of PAC or TAC tranches. They don’t receive interest or principal until all the other tranches in the series have been retired. Their market value can fluctuate widely.
Z tranches
________ tranches are purchased at a price deeply discounted below face value. Investors receive face value through regularly scheduled mortgage payments and prepayments. Their market value increases if interest rates drop and prepayments increase.
Principal only (PO) tranches
________ tranches appear with CMOs in which the interest rates are tied to an interest rate index (LIBOR, e.g.). Investors can use these investments to hedge interest rate risk on other investments.
Floating rate tranches
________ tranches are the second safest. They have somewhat less certain principal payments and are more subject to prepayment and extension risk. They have yields that are low but not as low as PAC tranches.
Targeted amortization class (TAC) tranches
______ bonds typically start at a low coupon rate but the rate increases at predetermined intervals, such as every five years. The issuer typically has the right to call the bonds at par value at the time the coupon rate is set to increase.
Step up coupon bonds
________ bonds are all issued at the same time and have the same maturity date.
Term bonds
- Most corporations issue term bonds because they lock in a coupon rate for a long period of time.
________ bonds are issued in successive years but have only one maturity date.
Series bonds
- Issuers pay interest only on the bonds they have issued so far.
- Construction companies that are building developments in several phases issue this type of bond.
________ bonds mature at regular intervals, (for example, 10% of the entire issue matures yearly).
Serial bonds
- Most municipal bonds are issued this way
- Usually issued by corporations and municipalities to fund projects that provide regular income streams.
- A serial bond that has more bonds maturing on the final maturity date is called a balloon issue.
________ bonds are backed by financial assets (stocks and bonds) that the issuer owns.
Collateral trust bonds
- A trustee holds the assets and sells them to pay off the bonds in the event of default.
________ bonds are backed by a firm other than the original issuer, usually a parent company.
Guaranteed bonds
- If the issuer defaults, the parent company pays off the bonds.
________ bonds are not registered in a particular person’s name. Instead the holder submits coupons to the issuer once every 6 months to receive the state interest amount.
Bearer bonds
- No longer issued
________ bonds in which the principal–but not interest–is registered in the investor’s name.
Partially registered bonds
- The bearer coupons can go to anyone but only the person named on the bond can claim the principal payment at maturity.
- No longer issued but still traded in market
_________ bonds are registered in an investor’s name and do not have any coupons attached.
Fully registered bonds
- Most common form of bond certificate
- An investor doesn’t have to submit coupons, interest is received automatically
________ bonds are recorded in electronic records, thus the investor doesn’t receive certificates or coupons.
Book entry bonds
- The US government and many municipalities issue securities this way.
- Becoming more and more common
