Fundamentals of Debt Securities

Question 1

Answer 1

Question 2

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

Answer 2

Sinking fund

Question 3

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

Answer 3

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

Question 4

Answer 4

Question 5

Answer 5

Question 6

What does yield-to-maturity (YTM) take into account that current yield does not? 3

Answer 6

1. Discount/Premium made or lost at maturity,
2. reinvestment of interest at YTM, and
3. time value of money

Question 7

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

Answer 7

YTC

Question 8

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

Answer 8

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

Question 9

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

Answer 9

Nominal Yield, Current Yield, YTM

Question 10

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

Answer 10

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

Question 11

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

Answer 11

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

Question 12

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

Answer 12

Annual Interest ÷ Current Market Price

Question 13

How do investors holding bearer bonds receive interest?

Answer 13

By clipping the attached coupons

Question 14

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

Answer 14

Serial bond

Question 15

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

Answer 15

Coupon rate and nominal yield

Question 16

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

Answer 16

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

Question 17

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

Answer 17

True

Question 18

How do investors receive interest on fully registered bonds?

Answer 18

Interest is mailed to the owner of record.

Question 19

Define defeasance as it relates to callable bonds.

Answer 19

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

Question 20

What is the highest credit rating?

Answer 20

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

Question 21

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

Answer 21

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

Question 22

What does a put feature on a bond allow?

Answer 22

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

Question 23

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

Answer 23

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

Question 24

Describe inflation or purchasing power risk.

Answer 24

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

Question 25

Describe call protection.

Answer 25

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

Question 26

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

Answer 26

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

Question 27

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

Answer 27

Given a yield change, long-term bonds move more in price (lower coupon or longer duration are also correct.)

Question 28

Bonds rated ___________ and higher are considered investment grade.

Answer 28

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

Question 29

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

Answer 29

Refunding would most likely occur when interest rates have fallen.

Question 30

Credit risk measures the issuer’s risk of \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_.

Answer 30

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

Question 31

What is the impact on bonds that have been prerefunded?

Answer 31

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

Question 32

Which interest rates are generally more volatile?

Answer 32

Short-term rates

Question 33

What is the original issue that is being refunded called?

Answer 33

Prerefunded bonds

Question 34

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

Answer 34

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

Question 35

Bondholders are also referred to as \_\_\_\_\_\_\_\_\_\_\_\_.

Answer 35

Bondholders are also referred to as creditors.

Question 36

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

Answer 36

Yes, when using a catastrophe call

Question 37

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

Answer 37

True

Question 38

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

Answer 38

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

Question 39

Calculate the price of a corporate bond quoted at 98 ¾.

Answer 39

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

Question 40

Define real interest rate (real rate of return).

Answer 40

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

Question 41

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

Answer 41

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

Question 42

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

Answer 42

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

Question 43

$\_\_\_\_\_\_ is the par value for bonds.

Answer 43

$1,000 is the par value for bonds.

Question 44

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

Answer 44

An escrow account managed by a trustee.

Question 45

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

Answer 45

OTC

Question 46

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

Answer 46

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

Question 47

Answer 47

Question 48

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

Answer 48

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

Question 49

Bond interest is stated ___________ and paid \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_.

Answer 49

Bond interest is stated annually and paid semi-annually.

Question 50

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

Answer 50

Term bonds are more likely to have a sinking fund.

Question 51

What does one basis point represent as a percentage?

Answer 51

0.01%

Question 52

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

Answer 52

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

Question 53

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

Answer 53

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

Question 54

Define duration.

Answer 54

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

Question 55

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

Answer 55

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

Question 56

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

Answer 56

$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 57

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

Answer 57

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

Question 58

\_\_\_\_\_\_\_\_\_ pay for bonds to be rated.

Answer 58

Issuers pay for bonds to be rated.

Question 59

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

Answer 59

False. There is an inverse relationship between interest rates and prices.

Question 60

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

Answer 60

YTM, Current Yield, Nominal Yield

Question 61

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

Answer 61

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