Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CFP NOV 2024 Prep > Investments Ch 7 > Flashcards

Investments Ch 7 Flashcards

You may prefer our related Brainscape-certified flashcards:
CFP® flashcards
1
Q

INTRODUCTION

A

INTRODUCTION
Fixed-income securities are credit instruments with fixed maturity
dates.
* The issuer promises to pay a rate of return on the face value,
followed by a repayment of the principal at maturity.
* Types include bonds, commercial paper, certificates of deposit,
mortgage-backed securities and other debt instruments.
* Combined with equity securities in a well-diversified portfolio

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

VARIETY OF ISSUERS

Variety of bond issuers include:

A

VARIETY OF ISSUERS
Variety of bond issuers include:
* Domestic and foreign governments
* Corporations
* U.S. Government, and its agencies, municipalities, and domestic
corporations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

KEY FEATURES OF BONDS
Term (Maturity)

A

KEY FEATURES OF BONDS

Term (Maturity)
* Impacts the yield that is received by the investor
* Most issued with term of 1-30 years
* Some bonds are callable.
* The fixed income market is segmented into short-term debt
(maturities up to one year) and long-term debt (maturities greater
than one year).

Coupon Rate
* The interest paid on bonds is known as the coupon payment.
* Can be fixed or floating

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

TYPES OF FIXED-INCOME SECURITIES

Fixed-income securities include a wide variety of instruments that
range in terms of risk, maturity and structure.

A

TYPES OF FIXED-INCOME SECURITIES

Fixed-income securities include a wide variety of instruments that
range in terms of risk, maturity and structure.

The largest fixed income markets are the
U.S. Treasury and the mortgage-related
bond markets, representing more than 50
percent and more than $24 trillion in
outstanding loan amounts

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

SHORT-TERM DEBT SECURITIES

A

SHORT-TERM DEBT SECURITIES

  • The fixed income market is segmented into short-term debt
    (maturities up to one year) and long-term debt (maturities greater
    than one year).
  • Short-term debt securities (money market securities) include:
  • Treasury Bills
  • commercial paper
  • money market deposit accounts
  • certificates of deposit
  • bankers’ acceptances
  • repurchase agreements
  • short-term municipal debt obligations
  • Eurodollar deposits
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

TREASURY BILLS (T-BILLS)

A

TREASURY BILLS (T-BILLS)

  • T-Bills are short-term U.S. Government debt securities issued at a
    discount.
  • T-Bills have 4-, 8-, 13-, 26-, or 52-week maturities
  • Considered to be default-risk free
  • Weekly auction
  • Competitive and non-competitive bid basis
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

TAXATION OF TREASURY BILLS (T-BILLS)

A

TAXATION OF TREASURY BILLS (T-BILLS)

  • Not subject to the original issue discount (OID) rules.
  • Subject only to federal tax.
  • At maturity, the amount paid for the T-Bill is subtracted from the par value of the instrument ($1,000).
  • If a T-Bill is sold prior to maturity, a capital gain or loss may result if
    interest rates have changed since the date of purchase.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

COMMERCIAL PAPER

Corporations can seek short term financing:

A

COMMERCIAL PAPER

Corporations can seek short term financing:

  • Short-term debt instruments issued in the public markets
  • Generally issued in denominations of $100,000 or more
  • Typically have a maturity of 270 days or less
  • Carry a small amount of default risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

TAXATION OF COMMERCIAL PAPER

A

TAXATION OF COMMERCIAL PAPER

  • Ordinary income
  • Sold before its maturity date, the investor may realize a short-term
    capital gain or loss.
  • Interest income is subject to state, local and federal income taxes.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

MONEY MARKET DEPOSIT ACCOUNTS

A

MONEY MARKET DEPOSIT ACCOUNTS

  • Typically pay short-term variable interest rate
  • MMDAs are accounts, not securities.
  • MMDAs are not transferrable.
  • Typically offered by banks or mutual fund companies
  • Interest earned is ordinary income.
  • Income is subject to federal, state, and local income tax
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

CERTIFICATE OF DEPOSITS (CDs)

A

CERTIFICATE OF DEPOSITS (CDs)

  • Pay rates of return that are higher than traditional deposit accounts
    (money markets).
  • Non-negotiable CDs are used for short-term deposits of at least
    $500.
  • Negotiable, or Jumbo CDs, are short-term deposits of $100,000 or
    more.
  • Subject to federal, state, and local income tax as ordinary income.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

BANKERS ACCEPTANCES

A

BANKERS ACCEPTANCES

  • Are negotiable instruments
  • Finance short-term debt needs for small companies
  • Often used in foreign commerce to facilitate a transaction
  • Higher interest rate than commercial paper due to higher risk
  • Once issued, can be traded in the secondary market
  • Subject to federal, state, and local income tax as ordinary income
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

REPURCHASE AGREEMENTS

A

REPURCHASE AGREEMENTS

  • Repos are very short-term (typical maturity dates of a few days).
  • Banks use Repos to borrow money from another bank using an
    underlying security as collateral.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

SHORT-TERM MUNICIPAL DEBT OBLIGATIONS

A

SHORT-TERM MUNICIPAL DEBT OBLIGATIONS

  • Bonds issued by state and local governments to finance their
    operations
  • Interest received on most municipal bonds is not subject to federal
    income tax and may be exempt from state income tax.
  • Any capital gain or loss on the sale of a municipal bond is fully
    subject to federal income tax.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

EURODOLLAR DEPOSITS

A

EURODOLLAR DEPOSITS

  • U.S. dollar denominated deposits in banks located outside of the
    United States.
  • The interest rate on Eurodollars is usually higher than the interest
    rate that can be obtained from other money-market instruments
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

COMMON BOND FEATURES & TERMINOLOGY

  • Coupon rate
  • Yield to maturity (YTM)
  • Debentures
  • Call provision
  • Puttable bond
  • Convertible bond
  • Zero-coupon bond
  • Serial bond
A

COMMON BOND FEATURES & TERMINOLOGY

  • Coupon rate
  • Yield to maturity (YTM)
  • Debentures
  • Call provision
  • Puttable bond
  • Convertible bond
  • Zero-coupon bond
  • Serial bond
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

ACCRUED INTEREST

A

ACCRUED INTEREST

  • Interest that has accrued since the payment of the last coupon payment.
    The buyer must pay the seller for the interest earned from the last
    coupon payment date to the date the bond is sold (settlement date).
  • Semi-annual coupon PMT x (Days since last coupon payment/Days in coupon period)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

ACCRUED INTEREST: EXAMPLE
Conrad buys a 6% coupon corporate bond that settles on October 1st.
The bond pays semi annual interest on Jan 1st and July 1st each year.
What is the amount of accrued interest that Conrad must pay to the seller of the bond?

A

ACCRUED INTEREST: EXAMPLE
Conrad buys a 6% coupon corporate bond that settles on October 1st. The bond pays semi annual interest on Jan 1st and July 1st each year.
What is the amount of accrued interest that Conrad must pay to the seller of the bond?

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

BOND PRICE QUOTES

A

BOND PRICE QUOTES

  • Corporate and municipal bonds are typically priced as a percentage
    of par value ($1,000).
  • In secondary market, investors pay the ask price plus accrued
    interest plus a commission.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

U.S. GOVERNMENT BONDS AND AGENCY SECURITIES

A

U.S. GOVERNMENT BONDS AND AGENCY SECURITIES

  • A variety of debt instruments are used to finance government
    expenditures.
  • Treasury notes are issued for maturities of 2, 3, 5, 7, and 10
    years.
  • Treasury Bonds are issued for terms greater than 10 years (up
    to 30).
  • Both make semiannual coupon payments.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

U.S. GOVERNMENT BOND: EXAMPLE

A

U.S. GOVERNMENT BOND: EXAMPLE

  • Treasury note and bond prices are quoted in dollars and fractions of a dollar.
  • The normal fraction used for Treasury security price quotes is 1/32.
  • A bid quote of 94.12 means $94 plus 12/32 of a dollar, or $94.375,
    for each $100 face value of the note
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

TREASURY STRIPS

A

TREASURY STRIPS

  • STRIPS: Separate Trading of Registered Interest and Principal of
    Securities
  • Financial institutions and government securities brokers and dealers “strip” each coupon and principal payment out of a Treasury bond or note and sell these strips to investors.
  • Turning a note or bond into Treasury STRIPs creates a series of
    zero-coupon bonds.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

TREASURY INFLATION PROTECTED SECURITIES (TIPS)

A

TREASURY INFLATION PROTECTED SECURITIES (TIPS)

  • Protect investors from purchasing power risk
  • Interest at a fixed rate
  • Principal is adjusted for inflation
  • TIPS are issued with maturities of 5, 10, and 30 years, are sold in
    increments of $100
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

TIPS : EXAMPLE
* An institutional investor purchases $100,000 worth of five-year
TIPS. The coupon rate on the note is 4.4%. The semi-annual
coupon payment is:

A

TIPS: EXAMPLE

  • An institutional investor purchases $100,000 worth of five-year
    TIPS. The coupon rate on the note is 4.4%. The semi-annual
    coupon payment is:

$100,000 × (0.044 ÷ 2) = $2,200

  • Six months later the CPI increases by 2.1%. The principal is
    adjusted. The new principal can be computed as:

$100,000 × 1.021 = $102,100

  • The higher principal base causes the coupon payments to increase
    as well. The adjusted semi-annual coupon payment is now:

$102,100 × (0.044 ÷ 2) = $2,246.20

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

U.S. SAVINGS BONDS

A

U.S. SAVINGS BONDS

  • U.S. Government savings bonds permit smaller investors to acquire
    an interest in government debt instruments and, in some cases,
    achieve favorable tax benefits.
  • Two types: EE and I (adjust for inflation) bonds

–Both types are sold at face value and accrue interest
– Not subject to OID tax rules but investors can elect to include
accrued interest on their tax return

  • Some bonds (Series E, H and HH ) can still be held but are no
    longer issued.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

U.S. SAVINGS BONDS: SUMMARY

A

U.S. SAVINGS BONDS: SUMMARY

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

U.S. GOVERNMENT AGENCY & SPONSORED SECURITIES

A

U.S. GOVERNMENT AGENCY & SPONSORED SECURITIES

The U.S. Government issues, or sponsors
debt instruments backed by collateral to
support important public policy goals.

  • Ginnie Mae (Government National Mortgage Association)
  • Fannie Mae (Federal National Mortgage Association)
  • Freddie Mac (Federal Home Loan Mortgage Corporation)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

MUNICIPAL BONDS

A

MUNICIPAL BONDS

  • Municipal bonds are debt instruments issued by state and local
    authorities, or territories of the United States to help fund spending
    initiatives.
  • Two types:
  • General Obligation
  • Revenue
  • Two classifications for tax purposes:
  • Public
  • Private
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

MUNICIPAL BONDS INTEREST

Tax Equivalent Yield (TEY).

A

MUNICIPAL BONDS INTEREST

  • Interest received is generally exempt from federal income tax.
  • One exclusion is the interest received from private activity
    bonds is subject to AMT (Alternative Minimum Tax).
  • To equate the yield on a tax-exempt municipal bond to the rate on a
    taxable bond, we calculate the Tax Equivalent Yield (TEY).
                Tax exempt yield  TEY=  -------------------------------------- 
       1  -   ( marginal tax rate )
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

MUNICIPAL BONDS: EXAMPLE
Consider two bonds: a municipal bond with a 4% interest rate, and a
corporate bond with a 5.8% interest rate. Assume a 32% federal
marginal income tax rate.
The Tax Equivalent Yield (TEY) of the municipal bond is:

A

MUNICIPAL BONDS: EXAMPLE

Consider two bonds: a municipal bond with a 4% interest rate, and a
corporate bond with a 5.8% interest rate. Assume a 32% federal
marginal income tax rate.

The Tax Equivalent Yield (TEY) of the municipal bond is:

                        4 % TEY =  -------------------------------- =   5.88% 
             1  -   (  . 32  )
31
Q

CORPORATE BONDS

A

CORPORATE BONDS

  • Corporations sell bonds to raise cash to finance their wealth
    increasing projects.
  • The legal document that outlines the rights of the owners is called
    the bond indenture.
  • Corporate Bonds are rated to reflect the default risk associated with
    a bond.
  • Bond ratings affect overall yield.
  • Corporate bond investors are subject to federal (and often state or
    local) income tax on the interest income.
32
Q

CORPORATE BOND RATINGS

A

CORPORATE BOND RATINGS

33
Q

COLLATERALIZED MORTGAGE OBLIGATIONS (CMOs)

A

COLLATERALIZED MORTGAGE OBLIGATIONS (CMOs)

  • Created by private investment firms
  • CMOs are backed, or collateralized, by a pool of underlying
    mortgages.
  • CMO investment pools can be split into tranches.
  • Each tranche has different risks and different maturities.
34
Q

COLLATERALIZED MORTGAGE OBLIGATIONS STRUCTURE

A

COLLATERALIZED MORTGAGE OBLIGATIONS STRUCTURE

35
Q

FOREIGN BONDS

A

FOREIGN BONDS

  • Foreign pay bonds are issued by foreign governments and
    corporations and stated in that country’s currency.
  • Eurodollar bonds are U.S. denominated bonds issued outside of
    the United States.
  • Yankee Bonds are U.S. denominated bonds that trade in the U.S.
    but are issued by foreign governments or companies.
  • Foreign bonds may provide diversification benefits.
  • The most common risk is exchange-rate risk.
36
Q

PROMISSORY NOTES

A

PROMISSORY NOTES

  • Promissory notes are private transactions, usually between individuals or between individuals and institutions, that create a fixed-income security for the holder.
  • The maker (the person borrowing the money) promises to pay the
    holder of the note the principal amount at maturity, as well as interest on the principal amount in periodic payments, or upon maturity of the note.
37
Q

GUARANTEED INCOME CONTRACTS (GICS)

A

GUARANTEED INCOME CONTRACTS (GICS)

  • A fixed income security which is similar to a certificate of deposit
  • Are sold by a large financial institution (insurance company)
  • Are sold to large, institutional investors (pension plan)
38
Q

CONVERTIBLE BONDS

A

CONVERTIBLE BONDS

A convertible security allows the holder to acquire shares of common
stock from the issuing company by exchanging the currently held
security under a specific formula.

                                    par value of convertible bond  Conversion price  = -------------------------------------------------- 
                                             Conversion Ratio
39
Q

CONVERTIBLE BONDS: EXAMPLE

A

CONVERTIBLE BONDS: EXAMPLE
Rouge Inc. issues a convertible bond with the following characteristics:
Par value = $1,000; 10-year term, 5% Coupon rate paid annually,
Conversion ratio = 40. The current price of the bond is $900. The
market yield is 6.3835%. The current stock price is $27.50 per share.
This stock pays no dividends.

                                  par value of convertible bond          $1,000  Conversion price  = ----------------------------------------------- =    ---------- = $25
                                          Conversion Ratio                          40
40
Q

CONVERSION VALUE

A

CONVERSION VALUE

Conversion value is helpful in assisting bondholders to decide whether or not they want to convert a bond to common stock

Conversion value = (Conversion Ratio) x (Stock price)

From the previous question, what is the conversion value if the investor converts the bond to stock?

41
Q

CONVERTIBLE BOND PRICE

A

CONVERTIBLE BOND PRICE

42
Q

A convertible bond has a par value of $1,000, but its current market price is $750. The current price of the issuing company’s stock is $17 and the conversion ratio is 30 shares. The bond’s conversion premium is closest to:

A

The bond is trading at $750 and the conversion option allows the holder to convert the bond into 30 shares.

                                  par value of convertible bond           750 Conversion price  = ----------------------------------------------- =    ---------- = $25
                                          Conversion Ratio                          30

Conversion Premium = Conversion Price - Current Price
$8 = $25 - $17

The current price per share is $17, so the premium is $8 ($25 - $17).

43
Q

Which of the following is not included in money market funds?

Repurchase agreements.
Eurodollars.
Real estate investment trusts.
Money market mutual funds.

A

real estate investment trusts.

Rationale

Real estate investment trusts are not short-term investments and are not included in money market funds.

44
Q

Which of the following types of municipal bonds has the highest credit risk?

A general obligation bond.
An insured general obligation bond.
A revenue bond.
An insured revenue bond.

A

A revenue bond.

Rationale

A revenue bond depends on the revenue from the dedicated project and is more risky than a general obligation bond.

45
Q

Which of the following is correct concerning CDs?

CDs and Jumbo CDs are used only by small investors since larger investors can earn a higher yield.

Jumbo CDs are non-negotiable.

Jumbo CDs are not eligible for FDIC insurance.

All CDs issued by federally insured banks are eligible for FDIC coverage up to the coverage limit.

A

All CDs issued by federally insured banks are eligible for FDIC coverage up to the coverage limit.

Rationale

All CDs issued by federally insured banks are eligible for FDIC coverage up to $250,000. Jumbo CDs are purchased by larger investors for much the same reason that smaller investors purchase regular CDs. Only Jumbo CDs are negotiable.

46
Q

Which of the following best describes the difference between a serial bond and a bond with a sinking fund?

Serial bonds require the company to periodically set aside funds into a trust to redeem the bonds at maturity.

Sinking fund bonds require the company to periodically redeem a portion of the bond prior to maturity.

Serial bonds require the company to periodically redeem a portion of the bond prior to maturity.

Serial bonds that pay a coupon are not subject to OID, while sinking fund bonds that pay a coupon are subject to OID.

A

Serial bonds require the company to periodically redeem a portion of the bond prior to maturity.

Rationale

Coupon paying bonds are not subject to OID regardless if they are sinking or serial.

47
Q

Which of the following is true about I bonds?

I bonds can be used to pay for qualified education expenses.
I bonds pay interest monthly.
I bonds are taxed the same as TIPS.
I bonds are issued at a discount.

A

I bonds can be used to pay for qualified education expenses.

Rationale

They can be used to pay for qualified education expenses.

48
Q

Which of the following statements is true regarding U.S. Government Agency bonds?

GNMA bonds have low default risk.
Mortgage backed securities have low prepayment risk.
Interest income and capital gains are exempt from state and local taxes.
Interest income and principal payments from the GNMA bonds are made monthly.

A

Interest income and principal payments from the GNMA bonds are made monthly.

Rationale

GNMA bonds have no default risk. Prepayment risk is a significant concern for MBS. CMOs allow an investor to mitigate prepayment risk, not MBS. All forms of income are taxable at the local, state and federal level.

49
Q

Which of the following is correct concerning bonds?

A callable bond may be redeemed by the issuer within the terms of the indenture agreement.
A putable bond may be redeemed by the issuer within the terms of the indenture agreement.
A putable bond is likely to be redeemed when interest rates have declined since issuance.
A callable bond is likely to be redeemed when interest rates have risen since issuance.

A

A callable bond may be redeemed by the issuer within the terms of the indenture agreement.

Rationale

A call feature gives the issuer the right to redeem the bond, which they are likely to do if rates have declined. A put feature gives the bondholder the right to redeem the bond, which they are likely to do if rates have risen.

50
Q

A coupon bond pays interest semi-annually and has an ask price of 107%. If the last interest payment was made two months ago and the coupon rate is 9%, what will the full “dirty” price of the bond be?

$1,070.
$1,085.
$1,100.
$1,115.

A

$1,085.

Rationale

Full (dirty) price of the bond = ask price + accrued interest.

  1. Ask price is 107% x $1,000 par value = $1,070.
  2. ( 9% = $ 1,000 $90 /yr = $45/ semi annual )
    therefore ,,,
    Accrued interest is 2/6 months x $45 coupon amount = $15.
  3. Full price = $1070 + $15 = $1,085.
51
Q

Which of the following is a disadvantage of bonds for the issuing corporation?

Interest paid by the issuing corporation on bonds is a deductible expense for the corporation for federal income tax purposes.
Bonds (debt) can increase the return on equity through favorable leverage.
Bonds typically require payment of both periodic interest and maturity value.
Bonds impact shareholder control.

A

Bonds typically require payment of both periodic interest and maturity value.

Rationale

The disadvantage is the requirement to pay interest and principal. Options a and b are advantages and option d is false.

52
Q

Which of the following statements is NOT correct?

Yields on bankers acceptances are typically higher than commercial paper since there is additional risk.

Negotiable CDs are deposits of $100,000 or more and are tradeable in the secondary market.

Commercial paper is not considered default risk free.

Repurchase agreements typically have maturities equal to that of commercial paper.

A

Repurchase agreements typically have maturities equal to that of commercial paper.

Rationale

Options a, b and c are correct. T-bills are default risk free, while commercial paper has some, although minor, default risk. Commercial paper has a maturity of 270 days or less and typically matures in less than six months.

53
Q

Which of the following is correct concerning T-bills?

Non-competitive bids determine the yield at any given auction.

Competitive bids determine the yield at any given auction.

Non-competitive bidders are not guaranteed to have their orders filled up to the auction maximum.

Competitive bidders are guaranteed to have their orders filled up to the auction maximum.

A

Competitive bids determine the yield at any given auction.

Rationale

Non-competitive bidders must accept the auction yield determined by the competitive bidders. Non-competitive bidders will have their orders filled up to the auction maximum, but that is not correct for the competitive bidders

54
Q

Commercial paper is most likely issued by:

The Federal Reserve bank.
Commercial banks.
Large, well-known companies.
A securities exchange.

A

Large, well-known companies.

Rationale

Large companies with excellent credit issue commercial paper.

55
Q

convertible bonds typically have which of the following characteristics?

Allow stockholders to convert their shares into bonds at a stated ratio.

Allow bondholders to convert their bonds into shares at a stated ratio.

Are more likely to be converted when a company’s stock underperforms.

Are likely to pay a higher yield than comparable non-convertible bonds.

A

allow bondholders to convert their bonds into shares at a stated ratio.

Rationale

Convertible bonds allow bondholders the right to convert to stock, not the other way around.
They are most likely to be converted when the stock performs well since the holder has the right to convert at a fixed value.
Since this feature is valuable to bondholders, they are likely to provide a lower yield than a comparable non-convertible bond.

56
Q

In a low interest rate environment, which of the following callable bonds are most likely to be called?

Zero-coupon bonds.
Coupon bonds selling at a discount.
Coupon bonds selling at a premium.
Floating rate bonds.

A

coupon bonds selling at a premium
.
Rationale

Bonds sell at a premium when prevailing interest rates are lower than the rate on the existing bonds.
Since new rates are lower, the issuing corporation will find it desirable to call the existing bonds and issue new bonds at the lower rates. T
he interest rate on floating rate bonds will adjust periodically to changes in prevailing interest rates.

57
Q

The issuing corporation has the option of retiring the bond, at a predetermined price, prior to the maturity date of the bond. What is this type of bond called?

A

A callable bond.

Rationale

A callable bond can be retired by the issuing corporation

58
Q

Which of the following is not correct about TIPS?

TIPS are issued directly from the U.S. Treasury.

The interest rate for TIPS changes based on inflation.

TIPS can be purchased on a competitive or noncompetitive basis.

With deflation, the interest payments will decrease for TIPS.

A

The interest rate for TIPS changes based on inflation.

Rationale

TIPS are issued by the U.S. Treasury on both a competitive and noncompetitive basis. T

The interest rate does not change.

Instead, the principal amount changes based on inflation or deflation.

59
Q

Money market securities are:

Readily marketable.
Not very volatile.
Highly liquid.
All of the above.

A

All of the above.
Rationale

Money market securities are marketable, liquid, and are stable in value (low volatility).

60
Q

Elmira is single and in the 37% federal and 4% state tax brackets, and she is subject to the federal 3.8% Net Investment Income Tax. She is considering the purchase of a municipal bond, issued in her state of residence, with a YTM of 7%.

What is Elmira’s tax equivalent yield on the bond?

A

12.68%.

Rationale

The tax equivalent yield is calculated using the formula:
[municipal rate÷(1-tax bracket)].

Municipal bond interest is not subject to tax at the federal level, and not subject to tax at the state level if the bondholder is a resident of the state in which the issuing municipality is located.

Elmira lives in the state in which the issuing municipality is located, so she will save a total of 37% + 3.8% + 4% = 44.8% in taxes by purchasing the municipal bond.

The tax equivalent yield is: [7÷(1-.448) = 12.68%)

61
Q

Which of the following statements is false?

Every bond has a maturity value.
Every bond has a yield to maturity.
Every bond has a stated rate of interest.
Every bond has coupon payments.

A

Every bond has coupon payments.

Rationale

Not all bonds are coupon bonds

62
Q

The price of a bond that a buyer would pay is equal to:

The asked price plus accrued interest.
The asked price less accrued interest.
The bid price plus accrued interest.
The bid price less accrued interest.

A

The asked price plus accrued interest.

Rationale

Bond prices are quoted “clean”, that is without accrued interest.

To purchase a bond the buyer must pay the ask price (the bid is the price the dealer will “bid” to allow an investor to sell a bond’) plus the accrued interest.

63
Q

Which of the following best describes the clean price of a corporate bond quoted at 98.03?

$98.03.
$98.09.
$980.30.
$980.94.

A

$980.30.

Rationale

Corporate bonds are quoted as a percentage of par value ($1000).
$980.94.

64
Q

Which of the following are the 3 largest segments of the U.S. bond market?

Municipal, corporate and Treasury.
Mortgage, corporate and Treasury.
Mortgage, corporate and Money Market.
Mortgage, Federal Agency and Treasury

A

Mortgage, corporate and Treasury.
Rationale

Corporate, mortgage and Treasury are each in excess of 15% of the total bond market, while all other categories are under 10% each.

65
Q

The yield to maturity on a bond is: ???

Lower than the coupon rate when the bond sells at a discount, and equal to the coupon rate when the bond sells at a premium.

The discount rate that will establish the present value of the payments equal to the current bond price.

Based on the assumption that payments received are reinvested at the coupon rate of return.

None of the above.

A

The discount rate that will establish the present value of the payments equal to the current bond price.

Rationale

Essentially the IRR. The rate that will equalize the negative and positive cash flows in present value terms.

66
Q

Which of the following statements regarding collateralized mortgage obligations (CMOs) is correct?

All tranches receive principal payments throughout the term.

All tranches are subject to prepayment risk.

Tranches with shorter maturities are not subject to prepayment risk.

Tranches with longer maturities are not subject to default risk.

A

All tranches are subject to prepayment risk.

Rationale

While interest is paid to all tranches, principal is paid only to the first tranche until that tranche is retired, then is paid to the second tranche until it is retired, and so on. All tranches are subject to default risk and prepayment risk.

67
Q

A Treasury bond has an ask price of 107.04 and a bid price of 107.00. What is the dollar price a buyer expects to pay ?

$1,070.000.
$1,070.040.
$1,070.13.
$1,071.25.

A

$1,071.25. ?????????

Rationale

4 ÷ 32 = 0.125 + 107 = 107.125

107.125% x $1,000 par value = $1,071.25

68
Q

A Treasury bond has an ask price of 107.04 and a bid price of 107.00. What is the dollar price a buyer expects to pay?

A

$1,071.25.

Rationale

4 ÷ 32 = 0.125 + 107 = 107.125

107.125% x $1,000 par value = $1,071.25

69
Q

T-bills pay accrued interest, How is it taxed ?

A

T-bills pay interest at maturity.

The client could purchase the t-bill in October of this year and it matures in April of next year.

They would earned half the interest in the current year and the other half in the next year, but it is paid and recognized in the next year.

70
Q

A twenty year zero coupon bond is more volatile in response to interest rate changes than a similar bond paying a 5% coupon.

A. True
B. False
A

A. True

71
Q

Private Activity Revenue bonds are not Federally tax exempt because they benefit private projects.

True
False
A

False

72
Q
A
73
Q
A

CFP NOV 2024 Prep (80 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions