Unit 3

Question 1

2 3 10 11 15 17 18 19 20 21 23 24

Question 2

What is the assumed par value of a bond?

Answer 2

$1000

Question 3

The major credit rating agencies are:

Answer 3

6

Question 4

How are muni bonds taxed?

Answer 4

Municipal bond interest is tax free at the federal level and tax free at the state level if the bondholder is a resident of the same state as the issuer.

Question 5

How are government securities taxed?

Answer 5

Treasury issues are taxed at the federal level.

Federal tax due each year on interest earned.
No state or local taxes

Question 6

Term maturity for bonds is:

Question 7

Balloon maturity for bonds is:

Answer 7

An issuer can schedule its bond’s maturity using elements of both serial and term maturities. This is known as a balloon maturity. The issuer repays part of the bond’s principal before the final maturity date, as with a serial maturity, but pays off the major portion of the bond at maturity.

Question 8

A serial maturity for bonds is:

Answer 8

A bond that is structured so that a portion of the principal is scheduled to mature at intervals over several years.

Question 9

When do corporate bonds pay interest?

Answer 9

For corporate bonds, interest is paid on semiannual payments.

(so this means it is half the amount of the nominal/coupon rate. For example: A 10% corporate bond would pay back $100 total annually, but paid in semiannual payments of $50)

Question 9

What are subordinated debt instruments?

Question 10

In a corporate bankruptcy what is the liquidation priority?
Secured Debtholders, Subordinated debtholders, common stockholders, general creditors, preferred stockholders.

Answer 10

For corporate bankruptcy’s, the order is:

Secured, Unsecured (including general creditors), holders of subordinated instruments, preferred stock holders, common stock holders

Question 11

All of the following are money market instruments except:

A) Warrants expiring within three months.
B) Banker’s acceptances.
C) Negotiable certificates of deposit.
D) Treasury bonds maturing within the next year.

Answer 11

(A) Warrants expiring within three months

Money market instruments are liquid debt securities maturing within a year. Warrants are EQUITY securities.

Question 12

All of the following are money market instruments except:

A) Warrants expiring within three months.
B) Banker’s acceptances.
C) Negotiable certificates of deposit.
D) Treasury bonds maturing within the next year.

Answer 12

(A) Warrants expiring within three months

Money market instruments are liquid debt securities maturing within a year. Warrants are EQUITY securities.

Question 13

Assuming $1,000 par value, a bond priced at $1,200 is trading at

Answer 13

a premium

Question 14

A customer buys a 10% bond with a current yield of 12% and holds the bond until one year before maturity. The bond is sold when current interest rates are 8%. Was the bond purchased at a discount or premium? Sold at a discount or premium?

Answer 14

When the current yield (12%) is higher than the coupon (10%), it means the bond was purchased at a discount. Because the question tells us that current interest rates are now 8%, the bond maturing within a year with a 10% coupon would now be able to be sold at a premium.

Question 15

The three major credit rating agencies are

Answer 15

Moody’s, Standard & Poor’s, and Fitch.

Question 16

What term financing do capital markets and money markets provide, respectively?

Answer 16

The capital market serves as a source of intermediate to long-term financing.

The money market, on the other hand, provides short-term financing.

Question 16

What term financing do capital markets and money markets provide, respectively?

Answer 16

The capital market serves as a source of intermediate to long-term financing.

The money market, on the other hand, provides short-term financing.

Question 17

What is the relationship between bond pricing and interest rates?

Answer 17

Bond prices have an inverse relationship to interest rates. If interest rates go up, bond 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.

Question 18

For a callable bond trading at a discount, the yields in ascending order are as follows:

Answer 18

Nominal(coupon), CY (current yield), YTM (yield to maturity), YTC (yield to call)

Question 19

Regarding bankruptcy proceedings who does the court protect and when from creditors?

Answer 19

courts protect both corporate and individual filers from creditors.

Bankruptcy is a general term for court procedures available to both individuals and businesses. During the proceedings, filers are protected by the court from creditors. Protection is granted independent of any actions to liquidate or file a plan for reorganization.

Question 20

Under what conditions do Income bonds pay interest?

Answer 20

Income bonds pay interest only if earnings are sufficient and the payments to be made are declared by the board of directors (BOD). This is not true of any of the other fixed-income securities listed (debentures, subordinated debentures, or convertible bonds).

Question 21

How are issues from a territory of the US taxed?

Answer 21

Issues from a territory of the United States (like Puerto Rico) produce interest that is tax free at the federal, state, and local level.

Question 22

In order for a gain to be taxed as a long-term capital gain, the position must be held for how long?

Answer 22

The rule is “more than one year.” If the test has calendar dates in the question, it will be clearly more than one year. Also, anything that protects the position (e.g., a long put) stops the clock for determining the one year.

Question 23

Which is not a type of maturity for debt securities: term, series, serial, balloon

Answer 23

series is not, but is often used as a distractor for serial.

Question 24

For a corporate bond, once issued, nominal yield moves in what direction with an increase in interest rates in the open market?

Answer 24

Nominal yield (coupon) does not change from the time of issue through maturity.

Current yield, yield to maturity, and yield to call, however, are impacted as bond prices react (inversely) to the movement of interest rates in the open market.

Question 25

What is the dollar value of a bond currently selling at 1051/2

Answer 25

$1,055

Question 26

The current yield on a bond with a coupon (nominal) rate of 7.5% currently selling at 105½ is approximately: (8.2%, 7.5%, 7.1%, 6.5%)

Answer 26

7.1%

A bond with a coupon rate of 7.5% pays $75 of interest annually. Current yield equals annual interest amount divided by bond market price, or $75 ÷ $1,055 = 7.109%, or approximately 7.1%.

Question 27

How much interest does a bond with a coupon rate of 7.5% pay annually?

Answer 27

$75

Question 28

Municipal revenue bonds:
A) do not require voter approval.
B) generally have a higher rating than general obligation (GO) bonds from the same issuer.
C) are not subject to statutory debt limits.
D) are backed and supported by ad valorem (property) taxes.

Answer 28

(A)(C)

Revenue bonds are designed to be self-supporting. They are backed by the revenue derived from the project funded by the bonds. Because they are not backed by property taxes, voter approval is not required.

GO bonds however are back by taxes, such as ad valorem (property) taxes, and therefore voter approval is generally required. With GO bonds, there is a debt ceiling or limit imposed on the issuer as well. Because they are backed by taxes, the issuer is limited as to how much can be issued. They generally have a higher rating than the same issuers’s revenue bonds.

Question 29

Do revenue bonds or general obligation bonds from the same issuer generally have a higher rating?

Answer 29

With GO bonds, there is a debt ceiling or limit imposed on the issuer as well. Because they are backed by taxes, the issuer is limited as to how much can be issued. They generally have a higher rating than the same issuer’s revenue bonds.

Question 30

A series maturity for bonds is:

Answer 30

Not a type of maturity. This is a distractor for serial maturity.

Question 31

In order to meet federal budget needs, the types and quantity of government securities to be issued are determined by:

Answer 31

It is the USA, the U.S. Treasury Department determines the types and quantities of government securities to be issued each week in order to accommodate budgetary needs.

At the time of issue, the Federal Reserve Board acts as the Treasury Departments agent.

Question 32

STRIPS are delivered in

Answer 32

book entry format

All U.S. government issues are delivered in book entry.

Question 33

All of the following are backed by the full faith and credit of the U.S. government except: (STRIPS, T-bonds, Treasury bills, T-notes, Treasury Receipts)

Answer 33

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.

Question 34

The repayment or maturity date of a banker’s acceptance is normally how long?

Answer 34

Banker’s acceptances are short-term time drafts, making them money market instruments. Maturity (payback) dates are normally between 1 day and 270 days (9 months).

Question 35

Which of the following is considered the primary risk of owning a corporate bond?

Answer 35

Default Risk

Question 36

What is considered the most concerning of the risks in debt securities?

Answer 36

All of these risks are present in owning bonds, but default risk is considered the most concerning of the risks in debt securities. All of the others here might hurt some, but default means you aren’t getting paid and might lose your investment.

Question 37

What are risks of owning a corporate bond?

Answer 37

Interest rate risk, Market risk, Purchasing power risk, Default risk, (more review in book)

Question 38

When purchasing a bond, the investor is taking on what type of position?

Answer 38

A creditor position.

When an investor is purchasing a bond, he is lending money to the issuer and becomes a creditor of the issuer.

Question 39

An investor holds a 5% corporate bond with a yield to maturity of 2.75%. How much will be received in interest on each of the scheduled interest payment dates?

Answer 39

With a 5% coupon (nominal or stated yield), this corporate bond will pay $50 annually (0.05 × $1,000 PAR). For corporate bonds, this is paid in semiannual interest payments in which each payment would be $25.

Question 40

What is the maximum maturity length for T-bills? What are the normal maturities for T-bills? (check book don’t know answer)

Answer 40

T-bills mature in 52 weeks or less.

Question 41

What is the maximum maturity length for T-bills? What are the normal maturity periods for T-bills? (check book don’t know answer)

Answer 41

T-bills mature in 52 weeks or less.

4, 8, 13, 17, 26, and 52 weeks

Question 42

List the following Treasury securities from the longest to the shortest maturities. (T-bill, T-bonds, T-notes)

Answer 42

T-bonds, T-bills, T-notes

Question 43

How are T-bonds, T-bills, and T-notes priced?

Answer 43

Bills are sold at a discount or at par (face value). When the bill matures, you are paid its face value.

Question 44

When is interest paid back on T-bills? How is it calculated?

Answer 44

For bills, “interest” is the difference between what you paid and the face value you get when the bill matures.

Question 45

How are T-bills taxed federal and state?

Answer 45

Federal tax due on interest earned
No state or local taxes

Question 46

Are T-bills eligible for STRIPs?

Answer 46

No

Question 47

What are T-notes sold in what maturity timelines?

Answer 47

We sell Treasury Notes for a term of 2, 3, 5, 7, or 10 years.

Question 48

Are T-notes eligible for STRIPs?

Answer 48

Yes

Question 49

Example of a STRIPs created from a T-bond with 10 years left to maturity:

Answer 49

A bond with 10 years remaining to maturity consists of:

a single principal payment due at maturity, and
twenty interest payments, one every six months over the next 10 years

When this bond is stripped, the principal payment and each of the 20 interest payments becomes a separate security. The one original security is now 21 separate new securities with unique Committee on Uniform Securities Identification Procedures (CUSIPs). All new security pieces pay at maturity.