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Investment Planning > Investment Planning 1 > Flashcards

Investment Planning 1 Flashcards

1
Q

Money Market Securities - 2 types

A

Money Market Deposit Accounts (MMDAs) -insured up to $250,000 (individual) by FDIC
Money Market Funds (MMFs) - not insured, but COVID created Money Market Mutual Fund Liquidity Facility (MMLF) to allow Federal Reserve to purchase distressed assets from MMFs and to provide liquidity.

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2
Q
  1. What are treasury bills?

2. Comparison between treasury bills, notes, and bonds?

A
  1. Short-term securities with maturities of one year or less. Issued at a discount from face value
  2. Bills mature in 3-12 months and are quoted in terms of discounted yield ($100 to $1 million). The difference between issue price and maturity is taxed as interest.

Notes are 1-10 years in maturity ($1,000 to $100,000)

Bonds are long term 10-30 years in maturity ($1,000 to $1 million)

Note: Interest is taxed at a federal rate, no state or local income tax.

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3
Q

What is bankers acceptance?

A

This instrument is used to finance imports and exports. A foreign exporter will ship goods to the U.S while the exporter wants assurance of payment when the goods arrive. These are bearer securities and can be held to maturity or can be traded. At a discount to face value

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4
Q

What is Eurodollars?

A

A eurodollar is a deposit in any foreign bank that is denominated in dollars

example: U.S dollar deposited in a Honk Kong Bank

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5
Q

What are yankee bonds?

A

These are dollar denominated bonds issued in the U.S by foreign banks and corporations. The bonds are issued in the U.S when market conditions are more favorable than the Eurobond market.

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6
Q

What are the Bond Fundamentals?

A

Bond: Bonds are a debt security which obligates the issuer to pay interest (usually semiannually) and to repay the principal amount when the debt matures

Par Value: Bonds are issued with a stated par value (face value usually $1,000) and a state rate of interest (coupon rate or nominal rate)

Discount Bond: Bond sells at a discount when par value is in excess of the bond’s purchase price

Premium Bond: Bond sells at a premium when the bond’s purchase price is in excess of par value

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7
Q

What are two main rating agencies and their letters for Investment Grade and Speculative Grade investments?

A

. . . . Standard & Poors Moody’s
Investment Grade: AAA, AA, A, BBB Aaa, Aa, A, Baa
Speculative Grade (junk bonds): BB and Below Ba and below

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8
Q

What is a debenture?

A

A debenture is a general debt obligation backed only by the integrity of the borrower, rather than collateral. It is a corporate bond.

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9
Q

What is an indenture? & what does it cover?

A

A formal agreement, also called a deed of trust, is between an issuer of bonds and the trustee. The indenture also provides for the appointment of a trustee to act on behalf of the bondholders.

This agreement covers:

  • form of bond
  • amount of the issue
  • property pledged
  • protective covenant
  • working capital & current ratio
  • redemption rights or call, put, or conversion provisions
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10
Q

What are the risks associated with corporate and municipal bonds?

A

DRIP

Default risk (credit risk) - A creditor may seize the collateral and sell it to recoup the principle

Reinvestment risk - As payments are received from an investment, interest rates fall. When the these funds are reinvested they will receive a lower yield

Interest rate risk - Rising interest rates cause bond prices to fall

Purchasing power risk - Inflation may lower purchasing power of bond interest risk payments and principal repayment, thereby forcing prices to fall. All bonds can be subject to this

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11
Q

What are the risks associated with government bonds? (except zeros)

A

RIP

Reinvestment risk

Interest Rate Risk

Purchasing power risk

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12
Q

What are risks with Treasury Strips?

A

IP

Interest rate risk

Purchasing power risk

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13
Q

What are original issue discount bonds?

A

Bond is discount from par value at time of issue.

Many original issue discount bonds are zero-coupon bonds originally sold far below par value and pay no interest until maturity when it pays par value

Discount on bond must be accreted over the bond’s life

Each year the portion of the discount that has been earned is included as taxable interest income and the bonds basis is increased.

Annual accretion amount is non taxable municipal interest income. If held to maturity there is no capital gain or loss.

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14
Q

Paul Jones bought some AAA corporate zero coupon bonds at issue this year. He has never
bought zeros before and is wondering how he needs to report the income?
A. There is no income to report yearly. At sale or maturity the income must be
reported.
B. The interest on zeros is tax-free.
C. Zero coupon bonds pay qualified dividends. They are reported on a separate tax
return because of their special tax rate (0%, 15%, and 20%).
D. The 1099 interest is reported on the front of the 1040 as gross income.

A

D. This should be reported as taxable interest

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15
Q

Len sucker was told by a registered representative to buy some 8% BB zero corporate bonds. He was told they were selling at a deep discount and pay phantom income. Len has
held the bonds for almost one year and received no income. How will he be taxed?

A. He will be taxed on 8% of the par value of the bond each year.
B. There is no tax if it is less than one year.
C. No tax will ever be reported if he holds the bonds until maturity.
D. He will be taxed on the interest that is accrued/accreted for the year.

A

D. Each year the interest is added to the bonds purchase price and interest increase the next year because the bond’s principal has increased

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16
Q

Identify the true statements regarding Treasury bills:
I. They are sold on a discounted yield basis.
II. They are only sold in denominations of $1,000 or higher.
III. They all mature in 3 months.
IV. They are sold at par.
V. They are sold by competitive bids.

A

D. They are sold at a discount. Bills also mature in 6 months

17
Q

What are treasury strips?

A

When coupons are stripped from treasury bonds, this creates U.S government zero coupon bonds called STRIPS. Investors who purchase STRIPs acquire direct obligation of the federal government. The discount on STRIPs is treated as taxable income, earned annually

18
Q

What are treasury inflation-protection securities? TIPS

A

TIPs offer protection against effects of inflation. They are marketable securities. Face value is adjusted semi annually to keep up with pace with inflation as measured by CPI every 6 months.

The investor is taxed annually on the interest payment plus the appreciation in face value. The increase in face value is only nominal or phantom income that is not collectible until the bond is sold or matures. However this income in taxable in the year it is accrued. TIPS are not subject to state and local taxes.

19
Q

Which of the following is (are) true about TIPS?

I. They are issued in minimum denominations of $1,000.
II. The interest rate is fixed.
III. Interest payments vary as the principal is adjusted for inflation and deflation.
IV. They are obligations of the federal government.
A. All of the Above
B. I, III
C. I, IV
D. II, IV

A

A. The interest rate is fixed, but the interest payments will vary depending on principle

20
Q

Jeanne bought a treasury inflation-protected security (TIPS) 3 years ago for $1,000. Since
then it has paid $90 in interest and has increased in principal by $150. If Jeanne sells the
security for $1,200, what amount must she report to the IRS?

A. A gain of $0
B. A gain of $50
C. A gain of $150
D. A gain of $200

A

B. Interest is taxable to the holder when received (no change in basis). Any increase in the inflation adjusted principal amount is treated as OID (taxable). Basis is $1000 + $50 = $1050

21
Q

What are EE bonds? Can EE bonds be in an UTMA? Can EE education bonds be in an UTMA?

A
  1. Non-marketable, nontransferable, cannot be used for collateral
    Sold at face value
    interest rate based on 10-year treasury note yields
    Fixed interest rate that is in effect at the time of of purchase
    Subject to federal taxation when redeemed (unless used as education bonds)
    Not subject to state or local taxes
  2. Yes, EE bonds can be in UTMA?
  3. No EE education bonds have to be owned my someone 24 or older. Normally a parent
22
Q

What are HH Bonds?

A

Americans still own old HH bonds
No longer exchangeable from EE bonds
Was only available by exchanging at least $500 in Series EE bonds
Pay semiannually (by check) subject to federal tax only
Nonmarketable

23
Q

What are I bonds?

A

Nonmarketable, non transferable, cannot be used for collateral
Sold at face value
Interest is composed of two parts:
-fixed based rate (remains the same for the life of bond)
-inflation adjustment (every 6 months)
-subject to federal taxation when redeemed (unless used as education bonds)
-not subject to state or local taxes

24
Q

Is the I bond inflation adjustment subject to tax each year?

A. Yes
B. No
C. The owner of the bond determines that
D. Only the interest portion of the bond is taxed

A

C. I bonds are taxed like EEs. The owner may choose to defer tax or pay annually

25
Q

Which of the following is/are true about Series EE and Series HH bonds?

I. EE and HH bond interest is taxed at maturity.
II. BE bonds are purchased at face value; HH bonds were purchased at par (when they
were being issued).
III. EE and HH bonds can be purchased directly or on the secondary market.
IV. Interest on EE bonds is not subject to state and local taxes; interest on HH bonds is
subject to state and local taxes.

A. All of the above
B. I, II, IV
C. I, III
D. II, IV
E. II
A

E. HH bond interest is taxed yearly. Both bonds are non-marketable with
interest not subject to state and local taxes. HH bonds are no longer issued.

26
Q

Which of the following situations will increase cash flow for a client today?

A. Increase the principal payments on an existing mortgage 31
B. Increase the auto insurance deductible (collision and other than collision)
C. Exchange the EEs for HHs
D. Change the investment option in the deferred variable annuity to the money market
sub-account

A

B. Increasing insurance deductibles generally lowers premiums. HHs pay interest semiannually but as of 2004, EEs can no longer be converted to HHs

27
Q

What are the types of Municipal bonds?

A
  1. General Obligation Bonds
  2. Revenue Bonds
  3. 1 Insured municipal bonds
  4. High-yield corporate bonds
  5. Convertible bonds
  6. Callable or put bonds
28
Q

What are general obligation bonds?

A

Backed by the full faith, credit, and taxing power of the issuer. GO bonds are considered the safest municipal credit. In event of default, GO bondholders have right to compel a tax levy to make payment on debt.

29
Q

What are revenue bonds?

A

Backed by a specific source of revenue to which the full faith and credit of the issuer is not pledged. Because revenue bonds are backed by a single source of funds (like toll roads, hospitals, or nuclear power plants), they have greater credit risk than GO bonds. Hence they offer higher yields.

30
Q

What are insured municipal bonds?

A

The insurers pay timely interest and principle when the issuer is in default. Municipal bond issuers are AMBAC (American Municipal Bond Assurance Corp), Berkshire, and assured guaranty.

31
Q

A client wants to cash in one bond. All the bonds have similar ratings and coupons. Which
one would you advise the customer to sell?

A. City improvement bond (GO)
B. Board of education bond (GO)
C. Hospital bond (revenue)D.
D. Insured backed toll road bond (revenue)

A

C. You should select the bond with the most credit risk

32
Q

Jody is assigned to design an investment portfolio for the company’s new pension assets.
Company trustees are very conservative. Money market assets total $100,000. How
will she position the assets?

A. Treasury bonds
B. Negotiable CD
C. GNMAs
D. EE bonds
E. FHLMC
A

B. CDs have the least risk (insured up to $250,000) with the term of the deposit and the yield agreed on. Treasury bonds and GNMAs are subject to RIP risk. FHLMC are not guaranteed by the U.S are subject to DRIP risks

33
Q

Which of the following is true about U.S. Treasury bonds?
A.
Treasuries do not have interest rate risk because the federal government
guarantees the coupon rate.
B.
Treasuries have default risk because the bonds are not guaranteed by the federal
government.
C.
D.
Treasuries have purchasing power risk due to their long maturities.
Treasuries do not have reinvestment rate risk because interest payments are
semiannual.

A

Ok

Investment Planning (1 decks)

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