Unit 2 | Types & Characteristics Of Fixed-Income (Debt) Securities Flashcards
According to Standard & Poor’s rating system, the 4 highest grades of bonds (from best to lowest grade) are
A. Aaa; Аа; А; Ваа.
B. A; Aa; Aaa; В.
C. B; A; AA; AAA.
D. AAA; AA; A; BBB.
D. Choice A would be correct if the question referred to Moody’s.
Which of the following statements regarding bond interest is true?
A. Bond prices have an inverse relationship to interest rates.
B. Bond prices have a direct relationship to interest rates.
C. The par value of a bond will increase as market interest rates fall.
D. The par value of a bond will decrease as market interest rates fall.
A | Bond prices have an inverse relationship to interest rates. If interest rates go up, prices for those bonds trading in the secondary markets will go down. Conversely, if interest rates decline, bond prices rise. Par value is a fixed number for the life of the bond.
LO 2.a
A bond would be considered speculative below which of the following Moody’s ratings?
A. А
B. Baa
С. ВВВ
D. Ba
B | A rating of Baa is the lowest investment-grade rating assigned by Moody’s. Any rating beneath this is considered speculative. If the question asked about Standard & Poor’s, then the correct choice would be BBB.
LO 2.b
What is the current yield of a 6% bond trading for 80 ($800)?
Find the solution as follows: $60 ÷ $800 = 7.5%. This bond is trading at a discount. When prices fall, yields rise. The current yield is greater than the nominal yield when bonds are trading at a discount.
What is the current yield of a 6% bond trading for 120 ($1,200)?
Find the solution as follows: $60 ÷ $1,200 = 5%. This bond is trading at a premium. The price is up, so the yield is down. The current yield is less than the nominal yield when bonds are trading at a premium.
Answer the following questions with premium, par, or discount.
A. If the bond has a YTC lower than its CY, it is trading at _____
B. If the bond has a YTM and CY that are equal, the bond is trading at _____
C. If the bond has a YTM less than its YTC, the bond is trading at _____
D. If a bond has a YTM greater than its coupon, the bond is trading at _____
A. premium;
B. par;
C. discount;
D. discount.
When a bond with a 6% coupon is selling for 90, each of the following statements is correct except
A. the current yield is approximately 6.67%.
B. the bond is selling at a discount.
C. the bondholder will receive two semiannual interest payments of $27 each.
D. the yield to maturity is slightly higher than the current yield.
C. A bond with a 6% coupon is going to make two semiannual interest payments of $30 each, regardless of the bond’s market price. After all, the loan was $1,000 at 6% interest, and that won’t change. A price of 90 is 90% of the $1,000 par-clearly a discount. The current yield is the $60 annual interest divided by the $900 price or 6.67%, and that is a bit lower than the yield to maturity because, if we hold the bond to maturity, we’re going to get back the full $1,000, which will represent a $100 profit. Please see the chart at the Test Topic Alert above.
Disregarding commissions, an investor selling a U.S. Treasury bond for a price of 104:16 will receive
A. $104.16.
В. $104.50.
C. $1,041.60.
D. $1,045.00.
D | Treasury bonds are quoted in 32nds and as a percentage of par. A quote of 104.16 is 104 16/32 or 104 1/2% of par. With par always being $1,000, the proceeds of the sale are $1,045.
LO 2.c
A 4.67% convertible debenture is selling at 102. It is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. If the stock were trading at parity with the debenture, the price of the stock would be
A. $25.00.
В. $25.25.
C. $25.50.
D. $44.35.
C | To determine the parity price of the common, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 /
$25 = 40 shares). Next, divide the current
price of the bond by the conversion ratio. The result is the parity price of the common stock (1,020 / 40 = $25.50).
LO 2.d
Five percent XYZ debentures are trading for $1,250. Other similarly rated bonds are being offered at 4.25%. What is the current yield on the 5% XYZ debentures?
A. 1.5%
B. 4.0%
C. 5.0%
D. 6.25%
B | Current yield is defined as the annual income (or coupon rate) from a bond divided by the bond’s current market price. Accordingly, $50
/ $1,250 = 04 × 100 = 4%. The current yield will be lower than the coupon rate when the bond is trading at a premium. Please note that there is unnecessary information given in this question. You do not need to know anything about other bonds.
LO 2.e
A company realizes money from the sale of surplus equipment. It would like to invest this money but will need it in 4-6 months and must take that into consideration when selecting an investment. You would recommend
A. preferred stock.
B. Treasury bills.
C. AAA-rated bonds with long-term maturities.
D. common stock.
B. For this client, the appropriate investment is a money market instrument, and nothing is safer than a T-bill.
One would expect to have checkbook access to a
А. СМО.
B. DDA.
C. GNMA.
D. SOFR.
B. DDA stands for demand deposit account, most often a checking account at a bank.
Which of the following statements about jumbo CDs is not correct?
A. Negotiable CDs do not have a prepayment penalty.
B. FDIC insurance applies up to $250,000.
C. They are secured by pledged assets of the issuing bank.
D. Jumbo CDs pay interest semiannually.
C | The jumbo (negotiable) CDs traded in the money market are unsecured debt of the issuer.
LO 2.f
Which of the following have no interest rate risk?
A. Negotiable CDs
B. Commercial paper
C. U.S. Treasury bonds
D. Time deposits at your local bank
D | Time deposits, either in the form of a savings account or a certificate of deposit, have no interest rate risk. Because these do not trade in the market, the value is not subject to changes in market interest rates.
LO 2.f
