Chapter 7: Fixed-Income Securities

Question 1

fixed-income securities

Answer 1

a debt instrument that pays interest for a period of time and then repays the face value at maturity.

Question 2

Examples of fixed-income securities

Answer 2

bonds
commercial paper
certificates of deposit
mortgage-backed securities

Question 3

what are the two largest markets for fixed-income securities?

Answer 3

US Treasury bonds and mortgage-related bonds.

Question 4

When would “calling a bond” benefit the security issuer?

Answer 4

when interest rates have declined.

Question 5

what is commerical paper?

Answer 5

short-term debt issued by corporations

Question 6

what kind of risk does commercial paper carry?

Answer 6

default risk

Question 7

what do banks use REPOs for?

Answer 7

to borrow from another bank to maintain the required cash reserves.

Question 8

what is the coupon rate of a bond?

Answer 8

the annual rate of interest paid on the face value

Question 9

what is the yield to maturity of a bond?

Answer 9

the internal rate of return (IRR) on the cash flows received by the investor.

Question 10

Secured Bonds

Answer 10

bonds that are backed by collateral

Question 11

zero-coupon bonds

Answer 11

bonds that do not make regular interst payments. matures at face value

Question 12

convertible bonds

Answer 12

bond can be converted into equity

Question 13

call provision

Answer 13

feature for the issuer to call back the bond before maturity

Question 14

puttable bond

Answer 14

enables the bond owner to sell (put) the bond back to the issuer at a predetermined price and time.

Question 15

when is a puttable bond beneficial for the security holder?

Answer 15

when interest rates rise.

Question 16

serial bond

Answer 16

bond with multiple maturity dates.

Question 17

when a bond’s price is more than its par value… (3)

Answer 17

1. the bond is selling at a premium
2. the coupon rate is higher than current interest rates.
3. callable bonds are likely to be called

Question 18

when a bond’s price is less than its par value…

Answer 18

1. the bond is selling at a discount
2. the coupon rate is lower than current interest rates.
3. puttable bonds are likely to be put.

Question 19

STRIPS

Answer 19

the government “strips” principal and coupon out of a treasury bond and sells it as a series of zero-coupon bonds.

Question 20

TIPS

Answer 20

treasury inflation protected securities

Question 21

what do US Savings Bonds enable?

Answer 21

permit smaller investors to acquire interest in government debt instruments, and in some cases allow for preferable tax treatment.

Question 22

the two main types of US Savings Bonds

Answer 22

EE and I bonds

Question 23

I Bonds

Answer 23

US Savings Bonds that are adjusted for inflation

Question 24

interest received from private purpose municipal bonds…

Answer 24

are subject to AMT (alternative minimum tax)

Question 25

Tax Equivalent Yield calculation

Answer 25

Tax Exempt Yield
/
(1 - marginal tax rate)

Question 26

After-Tax Return calculation

Answer 26

Taxable Return * (1 - marginal tax rate)

Question 27

main risks for Collateralized Mortgage Obligations (CMOs)

Answer 27

1. interest rate risk
2. default risk
3. prepayment risk

Question 28

what is the normal fraction use for treasury security prices?

Answer 28

1/32

Question 29

Treasury bills (TBILLS) and Treasury Bonds are exempt from which type of taxation?

Answer 29

State income tax

Question 30

what is default risk also known as?

Answer 30

credit risk

Question 31

Treasury bills (TBILLS) and Treasury Bonds are subject which type of taxation?

Answer 31

Federal

Question 32

are coupon bonds subject to OID?

Answer 32

NO

Question 33

Regarding competitive bids

Answer 33

the competitive bid determines the yield at auction

Question 34

Regarding non-competitive bids

Answer 34

the yield on the non-competitive bid is not guaranteed, instead, the competitive bidders are the ones to determine the yield.