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CFP July 2022 > Investments Lesson 6 > Flashcards

Investments Lesson 6 Flashcards

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1
Q

Rising interest rates mean investors can __. Bond holders selling must do so __?

A

Get higher coupon on new investments

At a discount

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2
Q

Drop in interest rates means coupons are __? Older bonds now worth __?

A

Lower

A premium

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3
Q

Coupon Rate (Nominal Yield)

A

Coupon Payment / Par

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4
Q

Current Yield

A

Coupon Payment / Price of the Bond

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5
Q

Example Exam Question:
Considering buying bond with current yield of 8% & selling for $900. Assuming bond pays annual coupon, what is coupon rate of this bond?

A. 5.5%
B. 6.0%
C. 7.2%
D. 8.2%
E. 9.0%
A

C

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6
Q

Example Exam Question:
What is yield to maturity on bond selling at 5% discount to par, paying 11.25% interest maturing in 7 years?

A. 11.23%
B. 12.34%
C. 13.10%
D. 13.79%

A

B

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7
Q

Example Exam Question:
Purchased bond for $880 with 9% coupon. Sold after 1 year paying current yield of 10%. What is holding period return?

A. 9.0%
B. 9.5%
C. 10.0%
D. 11.0%
E. 12.5%
A

E

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8
Q

Example Exam Question:
What is yield to call of bond selling at $1200, paying 12% interest semi annually, maturing in 10 years or bond callable in 5 years at 1050?

A. 3.96%
B. 7.91%
C. 10%
D. 12.91%

A

B

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9
Q

Yield Ladder Discount

A 
Highest to Lowest:
Yield to Call
Yield to Maturity
Current Yield
Nominal Yield
Call Mom’s Cell Now
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10
Q

Yield Ladder Premium

A 
Highest to Lowest:
Nominal Yield
Current Yield
Yield to Maturity
Yield to Call
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11
Q

Example Exam Question:
Treasury zero coupon bonds are particularly suited to which of the following types of accounts?

A. IRA
B. Trust
C. Corporate
D. Joint

A

A

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12
Q

Liquidity Preference Theory

A

Prefer liquidity & shorter term maturities

Higher maturities should have higher long term yield

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13
Q

Market Segmentation Theory

A

Yield curve depends on supply & demand
When supply > demand, rates are low
When demand > supply, rates are high

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14
Q

Expectations Theory

A

Yield curve reflects investor’s inflation expectations
When inflation expected to be lower in future, long term rates will be lower than short term resulting in inverted yield curve

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15
Q

Unbiased Expectations Theory

A

Related to term structure of interest rates

*formula provided

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16
Q

Bond Duration

A

Weighted average maturity of all cash flows
Bigger duration, more price sensitive/volatile to interest rate changes
Duration is moment in time investor immunized from interest rate risk & reinvestment rate risk
Modified duration is bond’s price sensitivity to changes in interest rates
Duration should equal investor’s time horizon to be effectively immunized

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17
Q

Zero coupon bond’s duration

A

Will always equal maturiry

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18
Q

As coupon rate increases, duration __?

A

Decreases

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19
Q

As yield to maturity increases, duration __?

A

Decreases

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20
Q

There is __ relationship between duration & term of bond?

A

Direct

21
Q

There is __ relationship between coupon rate/yield to maturity & duration?

A

Inverse

Interest rates are Inverse

22
Q

Example Exam Question:
Saving for child’s education 4 years from now. Which should invest in to immunize?
Bond A: AAA, 5 year maturity, 3.86 duration, 11% coupon, selling for $954
Bond B: AA, 4 year maturity, 3.2 duration, 12.5% coupon, selling for $982
Bond C, A, zero coupon, 5 year maturity, selling for $575

A. Bond B because maturity matched goal time frame
B. Bond A because higher credit rating than bond B
C. Bond C because zero coupon & duration is 5 years
D. Bond C because greater discount than bond A
E. Bond A because duration batched goal time frame

A

E

23
Q

Example Exam Question:
Need cash at end of 8 years. Which will immunize portfolio?

A. 10 year maturity coupon bond
B. 8 year maturity coupon bond
C. Series of treasury bills
D. 15 year zero coupon bond

A

A

24
Q

Example Exam Question:
Investor expects interest rates to increase, which type of bond would they prefer?
Bond A: AAA, 10 year maturity, 8.86 duration, 11% coupon, selling for $954
Bond B: AA, 5 year, 4.2 duration, 12.5% coupon selling for $982
Bond C: AA, zero coupon, 30 year maturity, selling for $575

A. A
B. B
C. C

A

B

25
Q

Example Exam Question:
Investor expects interest rates to decrease, which type of bond would they prefer?
Bond A: AAA, 10 year maturity, 8.86 duration, 11% coupon, selling for $954
Bond B: AA, 5 year, 4.2 duration, 12.5% coupon selling for $982
Bond C: AA, zero coupon, 30 year maturity, selling for $575

A. A
B. B
C. C

A

C

26
Q

Duration Assumptions:

A

Linear relationship between change in interest rates & bond prices
It’s actually curve linear
Convexity measures difference in price between duration estimate & actual price change
Good job estimating small price changes
Bad job estimating large price changes
Understates appreciation when interest rates decrease
Overstates depreciation when interest rates increase

27
Q

Tax Swap

A

Sell bond at gain & bond at loss to offset each other

Also sell bond at loss & buying new bond

28
Q

Barbells

A

Owning short & long term bonds

When interest rates move, only one set needs to be sold & restructured

29
Q

Laddered Bonds

A

Purchasing bonds with varying maturities
When bonds mature purchase new with longer maturities
Helps reduce interest rate risk because bonds are held to maturity

30
Q

Bullets

A

Very little payment then lump sum
Most mature in/around same time period
Zero coupon, treasuries, & corporates likely candidates
Typically used when investor has balloon payment on liability at some future date

31
Q

Preferred Stock

A

Debt features: stated par value, stated dividend rate
Equity feature: price May move with price of common stock
Dividend does not fluctuate
No maturity date
More closely tied with interest rates
Tax advantage: corporations receive 50 or 65% deduction of dividends (pref & common) based on percentage of ownership

32
Q

Example Exam Question:
Which would investor benefit most from tax advantages of preferred stocks?

A. Government
B. Individual
C. Corporate
D. Mutual funds
E. Nonprofit institutions
A

C

33
Q

Convertible Bonds

A

Investor has floor built in (par value of bond)

Conversion Value = par/conversion price x price of common stock

34
Q

Example Exam Question:
Purchased bond for $1050. Conversion price is $40. Market price of common stock is $35. What is conversion value of bond?

A. $300
B. $400
C. $875
D. $1050

A

C

35
Q

Capitalized Value

A

Capitalized Value = Net Operating Income / Capitalization Rate

36
Q

Capitalized Rate = NOI / cost

A

NOI=

Gross income - vacancy/collection costs - expenses+interest expense+depreciation expense

37
Q

Example Exam Question:
Owns 20 condos. Rent for $9167/month. 10% vacancy. Total expenses $1500000. Pays $250000 on mortgage. $50000 interest. 10% required rate of return. How much would investor be willing to pay?

A. $1000000
B. $5300720
C. $6300720
D. 7300720

A

B

38
Q

Lesson 6 Review:
Calculate new price when interest rates change. 10 year bond. Selling for $1071. Pays $80 annually. $1000 maturity value. If interest rates fall 100 basis points, new price of bond will:

A. Fall $40
B. Rise $68
C. Fall $71
D. Rise $74

A

D

39
Q

Lesson 6 Review:
Client asks about article read about US govt securities & inverted yield curve. You explain that:

A. Curve currently indicated long term rates lower than short term rates
B. Curve indicates short term rates being lower than long term rates
C. Indicates long term rates & short term rates are on par
D. Indicates long term rates higher than short term rates

A

A

40
Q

Lesson 6 Review:
Yield to maturity of bond selling at 5% discount to par paying 11.25% in annual interest on semi annual basis & maturing in 7 years?

A. 4.62 years
B. 6.78 years
C. 7.44 years
D. 1

A
41
Q

Lesson 6 Review:
Yield to maturity of 10 year bond selling in market at $1148 is 6%. Coupon is 8% annually. What is duration?

A. 4.62 years
B. 6.78
C. 7.44
D. 9.93

A

C

42
Q

Lesson 6 Review:
Yield to maturity of bond selling at 5% discount to par paying 11.25% in annual interest on semi annual basis & maturing in 7 years?

A. 11.23%
B. 12.34%
C. 13.10%
D. 13.79%

A

B

43
Q

Lesson 6 Review:
Contemplating purchase of 10 unit building. Rent each out at $700/month. Annual vacancy 10%. Additional revenue of $500/month. Expenses $15,000 annually. Similar properties selling using equity capitalization rate of 8%, how much should you offer on building?

A. $750000
B. $765000
C. $820000
D. $825000

A

D

44
Q

Lesson 6 Review:
Bonds paying 12% coupon selling for $1200. Which reflects lowest to highest yield relationship?

A. YTC,YTM,CY,CR
B. CR-CY,YTM,YTC
C. YTM-YTC-CY-CR
D. CY-CR-YTC-YTM

A

A

45
Q

Lesson 6 Review:
Bond is paying 9% coupon selling for $970. Which reflects lowest to highest yield relationship?

A. YTC,YTM,CY,CR
B. CR-CY,YTM,YTC
C. YTM-YTC-CY-CR
D. CY-CR-YTC-YTM

A

B

46
Q

Lesson 6 Review:
What is yield to maturity for 5 year term bond with 8% coupon selling for $930?

A. 8%
B. 9.8%
C. 4.9%
D. 4%

A

B

47
Q

Lesson 6 Review:
What is yield to call for 10 year bond with 6% coupon selling for $1200 callable in 5 years at $1050?

A. 1.3%
B. 2.6%
C. 3%
D. 6%

A

B

48
Q

Lesson 6 Review:
Which of following terms captures difference between duration’s estimate or bond’s price change & actual price change of a bond based on changes in interest rates?

A. Modified duration
B. Skewness
C. Yield curve
D. Convexity

A

D

CFP July 2022 (24 decks)

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