Practice questions on Debt Flashcards
An investor in the 32% tax bracket sells a bond with a face value of $10,000 for $9,200. If they immediately reinvest in a similar bond with a slightly different maturity date, what is their potential tax benefit?
a) $256
b) $320
c) $800
d) $3,200
Answer: a) $256
Explanation: The capital loss is $10,000 - $9,200 = $800. The tax benefit is calculated as $800 × 32% = $256.
Which of the following is NOT a valid reason to consider a tax swap?
a) To realize capital losses for tax purposes
b) To maintain a similar investment position
c) To guarantee a higher yield on the new investment
d) To potentially improve portfolio quality
Answer: C) To guarantee a higher yield on the new investment
Explanation: Tax swaps cannot guarantee higher yields. The primary purposes are tax-related benefits and potential portfolio improvements, not assured higher returns.
If an investor executes a tax swap resulting in a $5,000 capital loss, what is the maximum amount they can use to offset ordinary income in a single tax year?
a) $1,500
b) $3,000
c) $5,000
d) Unlimited
Answer: b) $3,000
Explanation: The IRS allows a maximum of $3,000 in capital losses to offset ordinary income in a single tax year. The remaining $2,000 would be carried forward to future tax years.
An investor buys a bond for $15,000 with a 4% coupon rate. Two years later, interest rates have risen, and the bond’s market value has fallen to $13,500. If the investor’s marginal tax rate is 24%, what is the after-tax cost of selling the bond and reinvesting in a new 5% coupon bond with the same face value?
a) $1,140
b) $1,500
c) $360
d) $864
Answer: A) $1,140
An investor has a $10,000 long-term capital gain and executes a tax swap resulting in a $12,000 short-term capital loss. Assuming a 15% long-term capital gains tax rate and a 24% ordinary income tax rate, what is the net tax benefit?
a) $1,980
b) $2,880
c) $1,500
d) $480
Answer: a) $1,980
Explanation: The $10,000 long-term gain is offset, saving $1,500 (15% of $10,000). The remaining $2,000 loss offsets ordinary income, saving $480 (24% of $2,000). Total savings: $1,500 + $480 = $1,980.
Which bond portfolio strategy involves concentrating investments in a specific maturity range?
a) Barbell
b) Bullet
c) Ladder
d) Butterfly
Answer: b) Bullet
Explanation: A bullet strategy concentrates bond investments in a specific maturity range.
In a barbell strategy, bonds are typically concentrated in:
a) Short-term and long-term maturities
b) Only medium-term maturities
c) Evenly across all maturities
d) Only long-term maturities
Answer: a) Short-term and long-term maturities
Explanation: A barbell strategy involves investing in short-term and long-term bonds, with little or no allocation to intermediate-term bonds.
Which strategy is most likely to benefit from a steepening yield curve?
a) Bullet
b) Ladder
c) Barbell
d) Inverse ladder
An investor expects interest rates to remain stable for the foreseeable future. Which strategy might be most appropriate?
a) Barbell
b) Bullet
c) Ladder
d) Inverted barbell
Answer: b) Bullet
Explanation: In a stable interest rate environment, a bullet strategy can potentially maximize yield by focusing on the most attractive part of the yield curve.
Which strategy provides the most consistent cash flow and reinvestment opportunities?
a) Barbell
b) Bullet
c) Ladder
d) Butterfly
Answer: c) Ladder
Explanation: A ladder strategy, with bonds maturing at regular intervals, provides consistent cash flow and reinvestment opportunities.
An investor is concerned about interest rate risk but also wants to maintain some exposure to higher yields. Which strategy might be most suitable?
a) Bullet
b) Ladder
c) Barbell
d) Inverse ladder
Answer: c) Barbell
Explanation: A barbell strategy can help manage interest rate risk through short-term bonds while still capturing higher yields with long-term bonds.
In which strategy would you be most likely to find an equal allocation to bonds maturing in 2, 4, 6, 8, and 10 years?
a) Barbell
b) Bullet
c) Ladder
d) Butterfly
Answer: c) Ladder
Explanation: A ladder strategy typically involves equal investments in bonds with regularly spaced maturities.
An investor believes that medium-term interest rates will fall relative to short and long-term rates. Which strategy might be most appropriate?
a) Barbell
b) Bullet
c) Ladder
d) Butterfly
Answer: b) Bullet
Explanation: A bullet strategy focusing on medium-term bonds could benefit if medium-term rates fall relative to other maturities.
Yvette is saving for her son’s college education. Her son is expected to start college in eight years. Which bond portfolio would likely be immunized with respect to this goal?
A. Weighted average time to maturity of bonds is 8 years with coupon of 6%
B. Weighted average time to maturity of bonds is 10 years with coupon of 0%
C. Weighted average time to maturity of bonds is 7 years with coupon of 3%
D. Weighted average time to maturity of bonds is 10 years with coupon of 5%
Which of the following statements regarding a bond ladder strategy is CORRECT?
A. A bond ladder strategy involves the purchase of very long-term and very short-term bonds.
B. Aladdered portfolio of bonds will provide lower yields than a portfolio consisting entirely of short-term bonds.
C. A bond ladder strategy is generally more aggressive than a bond barbell strategy.
D. A bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk.
ABC Corporation is a manufacturer of electronic devices used in the manufacturing of airplanes. Five years ago, the corporation floated a $100 million bond issue that would be used to finance improvements at its main manufacturing and distribution center. However, orders for its products have dropped dramatically due to demand being much lower than anticipated. The company believes it may miss paying the coupon payment on the bond issue in the upcoming fiscal year. The owners of the ABC Corporation bonds are facing which of the following types of risk?
A. Default risk
B. Reinvestment rate risk
C. Market risk
D. Regulation risk
What is the investment value of the convertible bond?
What is the downside risk for this GetGo convertible bond？
$1,226.00 current market price — $955.05 investment value = **$270.95 downside risk*
Remember, for downside risk, we take the difference between the current market price of the convertible bond and its investment value ($955.05), even though the conversion value ($1,103.45) is higher in this case.
