Debt Finals Missed Flashcards
Treasury Receipts pay interest: A. monthly B. quarterly C. semi-annually D. at maturity
The best answer is D. Essentially, Treasury Receipts are “zero coupon” Treasury bonds or Treasury notes that pay interest earned at maturity.
Interest received from all of the following securities is exempt from state and local taxes EXCEPT:
A. Fannie Mae Pass Through Certificates B. Treasury Notes C. Federal Farm Credit Funding Corporation Bonds D. Federal Home Loan Bank Bonds
The best answer is A. The interest income from direct issues of the U.S. Government and most agency obligations is subject to federal income tax but is exempt from state and local tax. An exception is the interest income received from mortgage backed pass through certificates (issued by GNMA, FNMA, FHLMC). This interest income is subject to both federal income tax and state and local tax. The logic behind this tax treatment is that the mortgage interest paid by the homeowners was fully deductible from both federal, state, and local taxes. When this interest is received by the certificate holder, both the federal and state government want to recapture this interest income and tax it.
CMO Targeted Amortization Classes (TACs) have:
A. lower prepayment risk, but the same extension risk as a Planned Amortization Class
B. higher prepayment risk, but the same extension risk as a Planned Amortization Class
C. the same level of prepayment risk but a lower level of extension risk than a Planned Amortization Class
D. the same level of prepayment risk but a higher level of extension risk than a Planned Amortization Class
The best answer is D. Companion classes are “split off” from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk. Thus, a TAC has the same level of prepayment risk as the PAC; but the TAC has a higher level of extension risk than the PAC.
A municipal dealer who solicits a “Bid Wanted”:
I must accept the first bid received
II need not accept the first bid received
III must have purchased the bonds prior to soliciting the bids
IV need not have purchased the bonds prior to soliciting the bids
A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. A municipal dealer can trade without physically having the position. If a dealer is requesting bids (that is, the dealer wishes to sell bonds), the dealer must simply intend to deliver those bonds by settlement. There is no requirement that the dealer must have the bonds, or must have purchased the bonds, prior to soliciting bids. Furthermore, there is no requirement that the dealer accept the first bid. The dealer will accept the highest bid received (if the bid amount is acceptable).
A municipality issues a zero-coupon bond that is callable at 104. If the municipality calls the bonds prior to maturity, the bondholder will receive:
A. par
B. 104% of par
C. current accreted value
D. 104% of current accreted value
The best answer is D. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.
Below is a listing of municipal bonds with the same credit ratings and maturities. Which bond has the lowest yield?
A. General Obligation Bond
B. Public Purpose Revenue Bond
C. Non-Essential Use Private Purpose Revenue Bond
D. Puerto Rico Bond
The best answer is D. Ranking the yields on these bonds from highest to lowest:
Private purpose revenue bond would have the highest yield because its income is Federally taxable via the AMT - Alternative Minimum Tax.
Public purpose revenue bond would have a lower yield because its interest income is exempt from Federal tax.
A general obligation bond would have a lower yield than a public purpose revenue bond because it has greater safety; as well as being exempt from Federal tax.
A Puerto Rico bond would have the lowest yield because its income is exempt from both Federal, State, and Local taxes for all investors, no matter where they live.
The principal advantage of purchasing a variable rate municipal note is:
A. The interest rate can be expected to remain fairly stable
B. The market value can be expected to remain fairly stable
C. The marketability risk can be expected to be lower
D. The credit risk can be expected to be lower
The best answer is B. With a fixed rate note, as interest rates rise or fall, the note’s value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes will fluctuate up or down, depending upon market interest rates. Thus, the note always gives a yield that approximates current interest rate levels so the market price of these securities will remain fairly constant.
These notes avoid “interest rate risk,” also known as market risk, since a rise in interest rates will not devalue these securities. However, they still may have marketability risk (the risk that the securities cannot be easily sold); and can have credit risk
All of the following can initiate repurchase agreements with government and agency securities as collateral EXCEPT:
A. Government securities dealers
B. Federal Reserve Banks
C. Federal Home Loan Banks
D. Commercial banks
The best answer is C. Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L’s.
A customer buys a Brokered CD for $100,000. Upon receipt of his next account statement, the customer sees that the market value of the CD is shown as $99,800. This would occur because:
A. interest rates have risen
B. interest rates have fallen
C. the broker’s commission for selling the CD has been subtracted out
D. the bank that issued the CD has charged an up-front handling fee
The best answer is A. If interest rates rise after issuance, the value of the CD in the secondary market will fall. Since the interest rate on the instrument is fixed at issuance, if market interest rates rise, then the price of this instrument must fall to bring its yield up to current market levels.
An analysis of yield curves of U.S. Government and lower medium quality corporate bonds shows the yield spread to be widening over the last 4 months. This is an indication that investors expect the economy to:
A. expand rapidly over the coming months
B. enter a recession over the coming months
C. grow slowly over the coming months
D. become more volatile in the coming months
The best answer is B. If the yield “spread” between Government bonds and lower medium quality corporate bonds is widening, this means that yields on lower grade corporate bonds are higher than normal relative to yields on Government bonds. This occurs because an excess of investors are buying Governments, pushing their yields down; or an excess of investors are selling lower grade corporate bonds, pushing their yields up. This behavior is typical when investors expect a recession. When a recession is expected, there is a “flight to quality.” Investors liquidate holdings that are vulnerable in a recession (low grade corporate bonds) and put the money into safe havens such as government bonds.
A municipality would defease its debt with all of the following EXCEPT:
A. U.S. Government securities
B. U.S. Government agency securities
C. AAA Corporate securities
ID. Bank certificates of deposit
The best answer is C.
A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality’s outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA corporates would not be used because they have too high a level of credit risk (if things get bad, the corporation’s credit rating could be downgraded; this is a highly unlikely event for government and agency securities).
(Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)
