UNIT 2 CHECKPOINT EXAM Flashcards
Your customer asks to buy a bond that carries a very attractive yield. When checking the bond you see that it has a B rating from the major credit rating agencies. When communicating this information to the customer, all of these terms might be used to describe the bond except
A) lower grade.
B) junk bond.
C) high-yield.
D) noninvestment grade.
A) lower grade.
Though a B rating is certainly a lower investment grade rating, that is not a typical term used in the industry. All of the other terms are terms normally associated with these bonds carrying a greater risk of default.
Which of these Treasury securities is in correct order of shortest to longest maturities?
A) Notes, bills, bonds
B) Notes, bonds, bills
C) Bills, notes, bonds
D) Bonds, notes, bills
C) Bills, notes, bonds
Bills have the shortest maturities with a maximum of one year (52 weeks), notes are from two to ten years, and bonds have maturities of more than ten years.
An investor who is seeking income might choose a corporate bond because
A) bonds can grow faster than the rate of inflation.
B) corporate bond interest is tax free.
C) a corporate bond pays a steady income and are generally reliable.
D) bonds pay a higher dividend than stocks.
C) a corporate bond pays a steady income and are generally reliable.
Corporate bonds are, depending on rating, generally reliable producers of income through interest payments. Bonds do not pay dividends, nor do they grow in value with inflation. Corporate interest is fully taxable.
Your customer calls you with a question. They tell you that they received a phone call from the bond desk telling them that they bought 20 bonds at 100. They want to know how much they paid for the bonds before any commission or other charges. You tell them
A) $2,000.
B) $200,000.
C) $1,000.
D) $20,000.
D) $20,000.
100 means they paid 100% of par ($1,000) per bond. They purchased 20 bonds, so the total amounts to $20,000. Note that the question asked how much they paid for the bonds, not the price per bond.
Your customer, Eleanor, purchased an InDebt Inc., 5% debenture at a price of 94. It matures in 12 years. What is the yield to maturity?
A) 5.73
B) 4.69
C) 5
D) 5.32
A) 5.73
You do not have to calculate YTM for this problem. You could if you really wanted to, but it is not necessary for the question. You do need to recall the bond inverse relationship chart. The bond is trading at a discount so the YTM must be higher than the coupon of 5%; that eliminates two responses. Note that YTM is higher than current yield, and that you do need to calculate CY. The bonds annual interest divided by the price (50/940) is 5.32% (the CY). Only one response is higher than 5.32%.
A bond’s rating is used primarily as a measure of its
A) volatility risk.
B) default risk.
C) interest rate risk.
D) purchasing power risk.
B) default risk.
Bond ratings from credit rating agencies are used to compare the relative risk of default. None of the others are issues of default.
Your customer is a resident of the state of Utah. She owns bonds issued by Puerto Rico. The interest from these bonds is
A) taxable at all levels because the bonds are not issued by a state.
B) taxable at the state level only.
C) taxable at the state and local level because she is not a resident of Puerto Rico, but still tax free at the Federal level.
D) tax free at all levels for U.S. citizens.
D) tax free at all levels for U.S. citizens.
Bonds issued by or from a territory of the United States have tax-free income at all levels to U.S. citizens.
Which of these is not backed by the full faith and credit of the U.S. government?
A) Treasury bills
B) Treasury bonds
C) Treasury STRIPS
D) Treasury receipts
D) Treasury receipts
Treasury bills, bonds, and notes are backed in full by the U.S. government. Treasury STRIPS are also backed in full by the U.S. government but Treasury receipts are not because they are issued by broker-dealers. Therefore the government’s backing can only be as good as the credit rating of the broker-dealer that issued them.
Your customer is in the 30% federal tax bracket. They consider purchasing a 7% corporate bond. Their after-tax yield would be
A) 7%.
B) 2.1%.
C) 10%.
D) 4.9%.
D) 4.9%.
The formula for the calculation is 7% (corporate rate) × (100% — 30% (tax bracket)).
7 × (1 – 0.3) =
= 7 × 0.7
= 4.9%
A customer says they have a diversified portfolio of notes and bonds. This means their portfolio consists primarily of
A) limited partnerships.
B) equity securities.
C) debt instruments.
D) hedge funds.
C) debt instruments.
Notes and bonds are types of debt and the term is often used generically to represent a debt securities.
All of these are debt-security-maturity schedules except
A) balloon.
B) series.
C) term.
D) serial.
B) series.
The three types of debt-security-maturity schedules are term, serial, and balloon. There is no series maturity schedule.
All of the following characteristics are true of securities issued by the Government National Mortgage Association except
A) they are called pass-through securities because the payments are made up of both interest and principal.
B) they are backed by the federal government.
C) they generate tax-free interest.
D) they pay monthly.
C) they generate tax-free interest.
GNMA interest is fully taxable. All the other statements are true.
Five years ago your client purchased at par $100,000 of New Brunswick City GO bonds maturing in 20 years from now and callable in six months. Interest rates have gone down over the last five years. Which of these should your client do?
I. Your client should recognize that the bonds have a high probability to be called.
II. Your client should recognize that the bonds are unlikely to be called.
III. Your client should expect the bond is trading at a large discount.
IV. Your client should expect the bonds are trading at a small premium.
A) I and III
B) I and IV
C) II and IV
D) II and III
B) I and IV
If rates have declined the bonds are likely trading at a premium and very likely to be called at the first call date in six months. The proximity of the call date means the bonds premium will be small.
The Alta Loma High School District is asking voters to approve a bond to fund the purchase of new computers and software. The bond will mature in 40 years and the interest and principal payments will be funded from real estate taxes. This is an example of a
A) an equipment trust bond.
B) a debenture.
C) revenue bond.
D) GO bond.
D) GO bond.
If a municipal bond requires a vote it is most likely a GO bond. Generally revenue bonds do not require a vote (note that there is no revenue generating source here). Debentures and equipment trust certificates are issued by corporations, not municipalities
Your customer, Shea, has a large portfolio of bonds and dividend paying stocks. Her primary interest is generating current income. She is trying to understand how taxes work for her T-bonds. You explain that
A) the interest from her T-bonds is exempt at all levels.
B) the interest from her T-bonds is exempt at the state level, but she will still owe taxes at the local and federal level.
C) the interest from her T-bonds is exempt at the federal level, but she will still owe taxes at the state and local level.
D) the interest from her T-bonds is exempt at the state and local level, but she will still owe taxes at the federal level.
D) the interest from her T-bonds is exempt at the state and local level, but she will still owe taxes at the federal level.
Securities issued by the federal government produce interest that is not taxed at the state or local level. It is taxed at the federal level.
