Debt Securities Flashcards
An investor purchases the following bonds, all at a premium above par value:
XYZ 5% non-callable bonds maturing in 15 years
XYZ 5.10% non-callable bonds maturing in 20 years
XYZ 5.25% non-callable bonds maturing in 25 years
Several months after these bonds are purchased, the going rates on bonds have moved an average of 20 basis points. Of this investor’s purchases, which will show the largest adjustment in terms of price because of the change in the going rate?
[A] The bonds are all trading in the secondary bond market and will all be affected equally.
[B] The 25-year bonds will be affected the most.
[C] The 15-year bonds will be affected the most.
[D] The bonds are all trading in the secondary bond market and have fixed coupons, so their prices will not be affected by fluctuations in new bond rates.
[B] The 25-year bonds will be affected the most.
Remember that short-term bonds react the quickest while long-term bonds react the most or greatest. So in this case, the 25-year bonds will see the largest adjustment over time.
An Open-end Mortgage Bond issued by a corporation is one in which the property used to secure the bonds:
[A] Cannot be used to secure a later loan unless the later loan is lesser in claim.
[B] Can be used to secure additional debt as long as the additional bonds are subordinated.
[C] Can be used to secure additional bonds and all bonds rank equally.
[D] Can be used to secure additional debt and in the event of bankruptcy bonds would be repaid by earliest maturities first.
[C] Can be used to secure additional bonds and all bonds rank equally.
An Open-end Mortgage Bond issued by a corporation is one in which the property used to secure the bonds can be used to secure additional bonds and all bonds rank equally.
What is the key factor that determines which CMO tranches receive principal payments from mortgages?
[A] Randomly selected
[B] By maturity date
[C] By interest rate
[D] By dollar value
[B] By maturity date
Principal payments and pre-payment are paid in order of the tranche’s maturity date. Early maturities are paid first and then later maturities.
One of your clients purchases a callable corporate bond. The bond is callable at 106.55. What will the customer receive if the corporation calls the bonds and the customer tenders them back to the corporation?
[A] The customer will receive $1,065.50 for the bond and accrued interest up to the call date will be subtracted from that figure.
[B] The customer will receive $1,065.50 for the bond and accrued interest up to the call date will be added to that figure.
[C] The customer will receive par value for the bond of $1,000 and will receive $65.50 in accrued interest.
[D] The customer will receive par value for the bond of $1,000 and will receive $106.55 in accrued interest.
[B] The customer will receive $1,065.50 for the bond and accrued interest up to the call date will be added to that figure.
This is an example of a corporate bond being quoted as a percentage of par. The 106.55 is the equivalent of 106.55% of the par value of $1,000. This means that the bond’s call value is $1,065.50 (1.0655 x 1,000) or ($10 X 106.55 = $1,065.50). The bond will be called at this call price and on top of that, the investor can expect to receive any accrued interest that would be due at the date of call on top of the call price.
A decrease of 10 basis points for a $1,000 bond would represent which of the following decreases in the price of the bond?
[A] $100.00
[B] $10.00
[C] $1.00
[D] $.10
[C] $1.00
Let’s first discuss the difference between a basis point and a bond point. A basis point is the measure of the change in yield. It is a small number, so a basis point measures that small change.
A basis point is equal to 1/100th of 1% of a bond or $.10. So on a $1,000 bond, one basis point is equal to $.10. So, ten basis points would be equal to $1.00. (10 X $.10 = $1.00)
A bond point deals with the price of a bond. A bond point is equal to 10 dollars.
Which of the following is an example of funded corporate debt?
[A] Long-term bonds
[B] Commercial paper
[C] Banker’s Acceptance
[D] Preferred stock
[A] Long-term bonds
Corporate funded debt is referred to as corporate debt with one or more years to maturity.
Which of the following is correct with regard to the current yield and coupon rate of a bond?
[A] The current yield of a bond is set for the life of the bond.
[B] The coupon rate of a bond fluctuates depending on the price of the bond.
[C] The coupon rate is re-set periodically by the issuer during the life of the bond.
[D] The current yield of a bond fluctuates depending on the price of the bond.
[D] The current yield of a bond fluctuates depending on the price of the bond.
The coupon rate of a bond is set for the life of the bond and the current yield fluctuates depending on the price of the bond. Bonds trading at a discount would have a yield higher than the coupon rate, whereas bonds trading at a premium would have a yield lower than the coupon rate. The issuer does not have discretion to re-set the coupon rate periodically.
Which of the following is issued by state and local governments and pays interest, typically semi-annually?
[A] Subscription Rights
[B] Subscription Warrants
[C] Corporate Bonds
[D] Municipal Bonds
[D] Municipal Bonds
Municipal bonds are issued by state and local governments and typically pay interest semi-annually. Corporate bonds are issued by corporations, but would pay interest semi-annually. Rights and warrants are derivative securities that allow an investor to purchase a specific number of shares at a specific price on a short-term (Rights) or long-term (warrants) basis. Rights and warrants do not pay dividends or interest.
Which of the following would be the effect on a collateralized mortgage obligation (CMO) if interest rates declined?
[A] Lengthen the average life of the CMO by 10 years or more.
[B] Decrease the market price of the CMO.
[C] Lengthen the average life of the CMO by 5 or more years.
[D] Shorten the average life of the CMO.
[D] Shorten the average life of the CMO.
A collateralized mortgage obligation (CMO) is subject to interest rate risk and implied call risk. CMOs are fixed income securities, so they are subject to inverse reaction like other fixed income securities: their current market prices will rise when interest rates fall.
Also, when interest rates go down (including home mortgage rates) homeowners will refinance their mortgages to take advantage of the lower mortgage rates. Consequently, they will pre-pay their existing mortgage prior to maturity and thus shorten (not lengthen) the average life of the CMO that is comprised of these mortgages.
Concerning bond prices and yields, if interest rates decline which of the following will be the effect?
[A] An increase in the price of bonds
[B] An increase in the yield on bonds
[C] A decrease in the price of bonds
[D] Bond prices and yields will remain unchanged.
[A] An increase in the price of bonds
When interest rates decline, bond prices will rise and yields will decline. When interest rates rise, bond prices will decline and yields will rise. There is an inverse relationship between interest rates and the price of bonds.
Collateral Mortgage Obligations are collateralized by all of the following EXCEPT:
[A] Conventional issuers.
[B] FHA mortgages.
[C] Fannie Maes.
[D] Sally Maes.
[D] Sally Maes.
CMO pools are issued and collateralized (secured with collateral) with mortgage loans from:
Ginnie Mae
Fannie Mae
Freddie Mac
FHA Mortgage Loans
Conventional / Private Mortgage Issuers
CMOs are NOT collateralized by Sally Mae (student loans).
Interest rate movements may affect all of the following regarding CMOs EXCEPT
[A] rate of payments.
[B] price.
[C] credit rating.
[D] rate of return.
[C] credit rating.
Credit Rating is not affected by interest rates. For exam purposes keep in mind that the credit rating is determined by the safety of the mortgages in the portfolio not by the level of interest rates–although they ultimately do have an effect on CMOs.
General Motors Corporation 6 1/2’s of ‘31 describe a bond with
[A] $65 annual interest with a quote of 310
[B] $65 annual interest maturing in 2031
[C] $650 annual interest maturing in 2031
[D] $6.50 annual interest with a quote of 310
[B] $65 annual interest maturing in 2031
$65 annual interest maturing in 2031. If instead of using the word “of” they would have used “at,” then the answer would have been A.
An investor buys two bonds: a 7.5% bond and a 8.5% bond, maturing in 2030, and at a 6.00 basis (ytm). The price of both of the bonds moves to 90.5. Which bond is likely to have the most price appreciation?
[A] The 7.5% bond
[B] The 8.5% bond
[C] Both will appreciate by the same amount.
[D] Neither, because the market price decreased.
[D] Neither, because the market price decreased.
The bonds were purchased with a 6% basis (ytm) when the coupons were higher at 7.5% and 8.5%. This indicates that the bonds had been purchased at a premium, or at a value higher than $1,000 (the par value). The question states the price of both bonds goes to 90.5 or $905, which is a quote at a discounted price (below par value); therefore, the price of the bonds would have declined. D is the correct answer.
Kalco Inc. issued a bond two years ago at par value. The bond is currently trading at 102. Which of the following statements is false about the yield on this bond?
[A] The nominal yield is less than the current yield.
[B] The current yield is lower than the nominal yield.
[C] The yield-to-maturity is lower than the nominal yield.
[D] The nominal yield always remains fixed.
[A] The nominal yield is less than the current yield.
The false statement is the nominal yield is less than the current yield. Bond prices and yields have an inverse relationship. As bond prices increase, yields decrease. Conversely, as bond prices decrease, yields increase. The question states that Kalco’s bond is trading above par. Par value is 100 ($1,000) and it is trading at 102 ($1,020). This means it is trading at a premium.
When a bond trades above its par value (at a premium), this means both the current yield and yield-to-maturity are below the nominal yield. The nominal yield is printed on the face of the bond. The nominal yield always remains fixed. The current yield and yield-to-maturity fluctuate inversely with bond market prices.
Of the following forms of bringing securities to market, which is most commonly used by the US Government for Treasury Securities?
[A] Initial Public Offering (IPO)
[B] Registered Secondary Distribution
[C] Competitive Bid Auction
[D] Negotiated Market
[C] Competitive Bid Auction
US Government Securities are generally brought to market using a competitive bidding auction process. IPOs and registered secondary distributions are typically used for OTC corporate common stock. Negotiated markets can be used for listed corporate securities and certain municipal bond offerings.
The yield on a convertible bond will decrease when the price of the underlying stock
[A] increases.
[B] decreases.
[C] is at parity with the bond
[D] remains unchanged.
[A] increases.
If a bond is convertible into common stock, the price of the bond will tend to move with the price of the stock. When the price of the underlying stock increases, the yield on the bond will decrease (remember, as bond yields decrease, bond prices increase).
The effect of steadily declining interest rates on the secondary bond market is:
Yields decrease Prices decrease Yields increase Prices increase [A] I, II [B] I, IV [C] II, III [D] III, IV
[A] I, II
When interest rates decline, yields decline, and prices rise. Think about the see-saw.
Collateralized Debt Obligations (CDOs) can be backed by all of the following, EXCEPT:
[A] Auto loans
[B] Credit card debt
[C] Mortgages
[D] A basket of stocks
[D] A basket of stocks
CDOs are asset-backed debt securities. They can be backed by various assets such as mortgages, auto loans, corporate debt, and credit card debt. CDOs would NOT be backed by stocks. Exchange-traded funds (ETFs) would be created using a basket of stocks.
The two issuance formats used when Corporate Bonds are issued, are Serial Form and Series Form. In describing Series Form, the issue would have
Different issuance dates The same issuance date Different maturity dates The same maturity date [A] I and III [B] I and IV [C] II and III [D] II and IV
[B] I and IV
A bond issued as Series Form, would have different issuance dates and the same maturity date.
Zero Coupon Bonds are purchased primarily by investors who are looking for
[A] Interest income
[B] Income from dividends
[C] Accretion
[D] Capital accumulation
[D] Capital accumulation
Since all interest is paid at maturity with the principal payment, the investor would have capital accumulation.
Three AA corporate bonds having a 6% coupon rate are selling at par. Bond A has a one year maturity. Bond B has a 20 year maturity and Bond C has a 40 year maturity. If there is a rise in the general level of interest rates, which of the following will occur?
[A] All bonds will rise in price; the shorter maturity will have the greater rise.
[B] All bonds will fall in price exactly the same amount because they are of identical quality and coupon rates.
[C] All bonds will fall in price; the shorter maturity will have the greater fall.
[D] All bonds will fall in price; the longer maturity will have the greater fall.
[D] All bonds will fall in price; the longer maturity will have the greater fall.
When interest rates change, prices of short term bonds react the quickest but long term bond prices react the greatest.
If an investor is primarily seeking capital gains, when would be the best time to buy bonds?
[A] When the interest rates are stable and are expected to remain stable.
[B] When interest rates are low and are expected to rise.
[C] When bond prices are low and interest rates are expected to rise.
[D] When interest rates are high and are expected to drop.
[D] When interest rates are high and are expected to drop.
A decline in interest rates causes prices to rise. An investor seeking capital gains would want to buy when interest rates are high and sell when they are low and prices have been driven up.
