UNIT 01.01 006 Flashcards
What happens to outstanding fixed-income securities when market interest rates drop?
Prices increase.
When interest rates drop, the price of outstanding bonds rises to adjust to the lower yields on bonds of comparable quality.
Which of the following statements about municipal bonds is not true?
A) Municipal bonds are generally considered riskier than corporate bonds.
B) Municipal bonds generally carry lower coupon rates than corporate bonds of the same quality.
C) The interest on municipal bonds is usually not subject to federal income tax.
D) Municipal bonds are bonds issued by governmental units at levels other than the federal.
A) Municipal bonds are generally considered riskier than corporate bonds.
One of your clients is interested in purchasing a new issue convertible bond. Which of the following statements regarding convertible bonds is not true?
A) You should expect a higher coupon rate than you would receive with a nonconvertible bond of the same maturity and rating.
B) This type of security offers possible downside protection during a period of falling stock prices.
C) Increased earnings by the issuer could lead to possible profit opportunities for convertible bondholders.
D) This security offers bondholders an option to trade their debt holding for equity in the issuer.
You should expect a higher coupon rate than you would receive with a nonconvertible bond of the same maturity and rating.
The conversion feature allows bondholders to convert their bonds into shares of stock. Increased earnings may have a positive effect on stock prices, and bonds generally offer an investor some downside protection when stock prices are falling. These are all desirable to the bondholder. Adding the desirable conversion feature to the bond allows the issuer to pay a lower coupon rate than they would pay with a nonconvertible bond.
A 55-year-old customer in the 18% tax bracket wants to maximize current return with a moderate degree of risk. He has just inherited $25,000 and seeks a bond investment. A suitable bond would have which of the following features?
Relatively high rating
The investor’s tax bracket is not high enough to take advantage of a bond’s tax-exempt status, but a bond with a low rating is not suitable because the investor is willing to bear only moderate risk. A bond with call protection and a relatively high rating would meet this customer’s needs.
ABC Corporation common stock currently trades at $50.00 a share. The quarterly dividend is $0.25. What is ABC Corporation’s dividend yield?
2.0%
The formula for dividend yield (also called current yield) is annual dividend divided by the current market value. Remember to multiply the quarterly dividend by four to get the annual dividend. In this example (0.25 × 4) / 50 = 0.02 (or 2%).
Seabird Airlines common stock pays a $0.50 quarterly dividend. Your customer purchased the stock for $50 a share and sold the stock one year later for $53 a share. What was the total return?
10%
The formula for calculating capital gains is income received plus gains (or minus losses) divided by cost basis equals total return. In this example, (2 + 3) / 50 = 0.10 (10%).
All of the following statements about put sellers are true except
A) they have taken on an obligation.
B) they are bearish on the underlying stock.
C) they receive money from the option transaction.
D) they hope the underlying stock holds steady or goes up in value.
they are bearish on the underlying stock.
Put sellers are paid the premium, in exchange for which they take on the obligation to buy stock at a fixed price, called the strike price. Whenever buying something (obligation to buy), the investor is bullish, not bearish.
All of the following debt instruments pay interest semiannually except
A) industrial development bonds.
B) Ginnie Mae pass-through certificates.
C) municipal revenue bonds.
D) municipal general obligation bonds.
Ginnie Mae pass-through certificates.
Ginnie Maes pay interest on a monthly basis, not semiannually.
Which of the following bond prices would fluctuate the least if interest rates fall?
A) 30-year corporate bond with duration of 14
B) 30-year zero coupon with duration of 15
C) 15-year unsecured bond with duration of 12
D) 30-year mortgage bond with duration of 26
15-year unsecured bond with duration of 12
Generally speaking, the rule of thumb is that bonds with long-term maturities will have greater fluctuations in price than will short-term maturities, given the same move in interest rates. What we need to pay attention to here is not the original maturity of the bond but how much time is left. The truest measure of sensitivity (volatility) is the bonds’ duration and the greater the duration, the greater the fluctuation in price when interest rates move.
Your customer purchased 200 shares of M-N-O, Inc., stock at $20 a share. After holding the position for five years they sold the stock for $32 a share. What are the results of the trade?
$2,400 gain
To calculate a gain or loss subtract the cost basis ($20) from the sales proceeds ($32). 32 – 20 = 12. Remember to multiply the “per share” result by the number of shares if the question does not specify “per share.”
Regarding U.S. Government securities, the term intermediate maturity best describes
A) T-bills.
B) T-notes.
C) T-STRIPS.
D) T-bonds.
T-notes.
Treasury notes mature in 2 to 10 years; they are considered intermediate-term bonds.
Money market instruments would include which of the following?
Banker’s acceptances
Commercial paper
Nonnegotiable certificates of deposit
Treasury STRIPS
Banker’s acceptances
Commercial paper
Money market instruments are high-quality debt securities issued with a maturity of one year or less. Negotiable CDs and Treasury bills are money market instruments, but nonnegotiable CDs and Treasury STRIPS are not.
A customer purchases $50,000 worth of 10% corporate bonds at par. At the end of the day, the bonds close down a half point. The customer has a loss of
$250.
The customer holds fifty $1,000 bonds. One bond point equals $10. Therefore, if each bond decreases by a half point, the loss is $5 per bond; multiplied by 50 bonds, this equals $250.
Which of the following statements regarding Treasury bills is true?
A) They pay a fixed rate of interest semiannually.
B) They mature in 10 years.
C) They are issued at a discount.
D) They mature in 10 years or more.
They are issued at a discount.
T-bills are sold at a discount and mature in 4, 13, 26, or 52 weeks. Although they mature at face value, they do not make interim interest payments. Currently, Treasury is not issuing 52-week T-bills.
Which of the following securities has a duration shorter than maturity?
A) NewCorp, Inc., 8% 10-year bond maturing in 5 years
B) DEF zero-coupon bond maturing in 8 months
C) ABC zero-coupon bond maturing in 5 years
D) Treasury STRIP maturing in 4 years
NewCorp, Inc., 8% 10-year bond maturing in 5 years
Zero-coupon bonds, because they make no interim payments, have duration equal to maturity. A bond that makes interim payments has a duration that is shorter than its maturity. Only the NewCorp bond is interest-bearing.
