Chapter 8 - Fundamentals of Debt Securities

Question 1

Bondholders are also referred to as _______.

Answer 1

Bondholders are also referred to as creditors

Question 2

$_____ is the par value for bonds.

Answer 2

$1,000 is the par value for bonds

Question 3

Calculate the price of a corporate bond quoted at 98 ¾

Answer 3

Convert fraction into a decimal: 3 ÷ 4 = .75 and then multiply $1,000 by 98.75% = $987.50

Question 4

A bond trading at a price below par is a _______ bond.

Answer 4

A bond trading at a prcie below par is a discount bond

Question 5

A bond trading at a price of $1,000 is a _____ bond

Answer 5

A bond trading at a price of $1,000 is a par bond

Question 6

A bond trading at a price above par is a _____ bond.

Answer 6

A bond trading at a price above par is a premium bond.

Question 7

What are two synonymous terms for a bond’s interest rate?

Answer 7

• Coupon Rate
• Nominal Yield

Question 8

A bond with an 8% coupon would pay how much interest per year?

Answer 8

$80.00. Par x Rate ($1,000 x 8%)

Question 9

Bond interest is stated ________ and paid __________.

Answer 9

Bond interest is stated annually and paid semi-annually.

Question 10

What does yield-to-maturity (YTM) take into account that current yield does not?

Answer 10

Discount/premium made or lost at maturity, reinvestment of interest at YTM, and time value of money

Question 11

When discussing a bond, the YTM may also be referred to as _______.

Answer 11

When discussing a bond, the YTM may also be referred to as basis.

Question 12

Credit risk measures the issuer’s risk of __________.

Answer 12

Credit risk measures the issuer’s risk of default on debt service.

Question 13

_______ pay for bonds to be rated.

Answer 13

Issuers pay for bonds to be rated.

Question 14

What is the highest credit rating?

Answer 14

AAA for S&P and Fitch, and Aaa for Moody’s

Question 15

Bonds rated _________ and higher are considered investment grade.

Answer 15

Bonds rated BBB (for S&P and Fitch) or Baa (for Moody’s) and higher are considered investment grade.

Question 16

How does S&P and Moody’s further differentiate their ratings?

Answer 16

S&P uses + or - , while Moody’s uses 1, 2, 3.

Question 17

Bonds rated BB (Ba) or lower are considered ____________ bonds.

Answer 17

Bonds rated BB (Ba) or lower are considered speculative or junk bonds.

Question 18

True or False: When interest rates go up, bonds prices go up, and when interest rates go down, bond prices go down.

Answer 18

False.

There is an inverse relationship between interest rates and prices.

Question 19

Given a yield change, _______ bonds move more in price.

Answer 19

Given a yield change, long-term bonds move more in price

(lower coupon or longer duration are also correct.)

Question 20

Define real interest rate (real rate of return).

Answer 20

Interest rate minus the inflation rate

(e.g., Bond yielding 8% when inflation is 3% has a real interest rate of 5%).

Question 21

Which interest rates are generally more volatile?

Answer 21

Short-term rates

Question 22

A type of maturity where all bonds mature on one specific date is called a _______ bond.

Answer 22

A type of maturity where all bonds mature on one specific date is called a term bond.

Question 23

What is the maturity type where a portion of principal is retired each year?

Answer 23

Serial bond

Question 24

What does one basis point represent as a percentage?

Answer 24

0.01%

Question 25

How do investors holding bearer bonds receive interest?

Answer 25

By clipping the attached coupons

Question 26

How do investors receive interest on fully registered bonds?

Answer 26

Interest is mailed to the owner of record.

Question 27

The term ________ refers to the form of issuance where there are no physical certificates delivered.

Answer 27

The term **Book Entry** refers to the form of issuance where there are no physical certificates delivered.

Question 28

True or False: Investors may exercise a bond's call privilege any time after issuance.

Answer 28

False. Only issuers may exercise the call privilege after the call protection period has passed.

Question 29

The _____________ represents the amount above par that issuers pay to redeem bonds early.

Answer 29

The **call premium** represents the amount above par that issuers pay to redeem bonds early.

Question 30

Describe call protection.

Answer 30

The number of years after issuance during which bonds may not be called by the issuer

Question 31

May bonds be called early due to an event which destroys the source of revenue backing the bond?

Answer 31

Yes, when using a catastrophe call

Question 32

\_\_\_\_\_\_\_\_\_\_\_ refers to a situation where an issuer sells a new bond to pay off the debt of an old bond.

Answer 32

**Refunding** refers to a situation where an issuer sells a new bond to pay off the debt of an old bond.

Question 33

Refunding would most likely occur when interest rates have \_\_\_\_\_\_\_\_.

Answer 33

Refunding would most likely occur when interest rates have **fallen.**

Question 34

When executing a refunding, into what account would the new issue proceeds be placed?

Answer 34

An escrow account managed by a trustee.

Question 35

The money held in escrow from a refunding is invested in \_\_\_\_\_\_\_\_\_\_\_\_\_.

Answer 35

The money held in escrow from a refunding is invested in **U.S. Government securities.**

Question 36

What is the original issue that is being refunded called?

Answer 36

Prerefunded bonds

Question 37

What is the impact on bonds that have been prerefunded?

Answer 37

Credit is improved and the issue is considered defeased for the issuer.

Question 38

Are prerefunded bonds quoted on a yield-to-maturity (YTM) or yield-to-call (YTC) basis?

Answer 38

YTC

Question 39

Into what does an issuer periodically set aside money for retiring debt?

Answer 39

Sinking fund

Question 40

Are serial or term bonds more likely to have a sinking fund?

Answer 40

Term bonds are more likely to have a sinking fund.

Question 41

What does a put feature on a bond allow?

Answer 41

Bondholders may put (redeem) the bond back to the issuer prior to maturity.

Question 42

True or False: Bonds with call features have higher yields, while bonds with put features have lower yields.

Answer 42

True

Question 43

Describe inflation or purchasing power risk.

Answer 43

The risk that today’s investment will not be worth as much when the money is received in the future.

Question 44

Accrued interest on T-Notes and T-Bonds is calculated using ______ days in the month and _____ days in the year.

Answer 44

Accrued interest on T-Notes and T-Bonds is calculated using **actual** days in the month and **365** days in the year.

Question 45

Are U.S. Government and municipal securities traded on an exchange or OTC?

Answer 45

OTC

Question 46

Define defeasance as it relates to callable bonds.

Answer 46

A provision that voids a bond or loan when the borrower sets aside cash or bonds sufficient to pay debt service

Question 47

What can be determined if given the following bond information? 7% bond, due 6/1/20XX, yielding 8.7%.

Answer 47

$70 interest ($35 each 6/1 and 12/1), matures on June 1, 20XX, is a discount since YTM (8.7%) is above the nominal (7%)

Question 48

The __________ the duration, the greater the bond's price sensitivity.

Answer 48

The **longer/greater** the duration, the greater the bond's price sensitivity.

Question 49

Rank in order, from highest to lowest, the three yields on a bond priced at a discount.

Answer 49

YTM, Current Yield, Nominal Yield

Question 50

Rank in order, from highest to lowest, the three yields on a bond priced at a premium.

Answer 50

Nominal Yield, Current Yield, YTM

Question 51

A bond has a 12% coupon and is trading for $1,200. What is a realistic YTM for this bond?

Answer 51

YTM must be less than 10% since the current yield ($120 ÷ $1,200) is 10%.

Question 52

Define duration.

Answer 52

The measure, expressed in years, of a bond's price sensitivity to interest rate changes

Question 53

What does a normal, positive, ascending, or upward sloping yield curve indicate?

Answer 53

Bonds with longer maturities have higher yields than bonds with shorter maturities.

Question 54

The yield curve is ____________ when short-term bonds have higher yields than long-term bonds.

Answer 54

The yield curve is **inverted (negative/descending)** when short-term bond yields are higher than long-term bonds.

Question 55

True or False: A flat yield curve reflects both long and short-term yields being the same.

Answer 55

True

Question 56

Answer 56

Question 57

Answer 57

Question 58

Answer 58

Question 59

Answer 59

Question 60

What is the dollar price of a T-bond with a bid of 98-24 and a par value of $100?

Answer 60

98 and 24/32. Convert fraction into a decimal 24 ÷ 32 = .75. Now multiply $100 by 98.75% = $98.75.

Question 61

What is the formula for calculating a bond's current yield?

Answer 61

Annual Interest ÷ Current Market Price