Deck 10: Fixed-Income Securities

Question 1

The primary reasons for owning bonds are the income they provide and also the stability they bring to an investment portfolio.

Answer 1

True

Question 2

Which of the following are advantages of owning bonds?
I) diversification properties
II) higher long-term returns than equity holdings
III) current income
IV) lower risk than stocks

A) I and II only
B) I, III and IV only
C) I, II and III only
D) I, II, III and IV

Answer 2

B

Question 3

Bond prices are stable over any five- to ten-year period.

Answer 3

False

Question 4

The interest payment on a 7% coupon, semi-annual bond is $35 every 6 months.

Question 5

A semi-annual coupon rate of 7% means that the bond will pay $70 interest every 6 months.

Question 6

The bond market has occasionally outperformed the stock market for several years at a time.

Question 7

Although bond prices can move substantially up or down, the income stream is stable and predictable.

Question 8

Discuss at least three differences between investing in stocks and investing in bonds.

Question 9

In a severe recession, the major source of risk faced by investors who purchase junk bonds is

A) purchasing power risk.
B) interest rate risk.
C) liquidity risk.
D) default risk.

Question 10

The bond market is considered bearish when

A) market interest rates are low or falling.
B) market interest rates are high or rising.
C) the risk-free rate of return exceeds the required rate of return.
D) more bonds are called than issued over a given period of time.

Question 11

The only source of income from bonds is the interest payments.

Question 12

Which of the following types of risk affect bonds?
I) call risk
II) business risk
III) purchasing power risk
IV) liquidity risk

A) III and IV only
B) II, III and IV only
C) I, III and IV only
D) I, II, III and IV

Question 13

Bond investors will experience capital gains when

A) market interest rates are falling.
B) market interest rates are rising.
C) the required rate of return exceeds the risk-free rate of return.
D) more bonds are called than issued over a given period of time.

Question 14

In times of economic uncertainty, yields on______ bonds tend to rise and yields on______ bonds tend to fall.

A) junk; AA rated
B) government; corporate
C) corporate; government
D) Treasury; municipal.

Question 15

When bonds are initially added to an all-equity portfolio the

A) level of risk of the portfolio is impacted more than the rate of return.
B) rate of return on the portfolio is impacted more than the level of risk.
C) level of risk and the rate of return are equally impacted.
D) rate of return is not impacted but the level of risk is lowered.

Question 16

Speculative investors seeking short-term capital gains will profit when

A) inflation rates are rising.
B) interest rates are stable.
C) interest rates are falling.
D) interest rates are rising.

Question 17

Bondholders usually have capital gains when interest rates are rising.

Question 18

Which type of risk is based on the financial integrity of a bond issuer?

A) liquidity risk
B) call risk
C) default risk
D) interest rate risk

Question 19

Under normal economic conditions, the major source of risk faced by investors who purchase investment grade bonds is

A) purchasing power risk.
B) interest rate risk.
C) liquidity risk.
D) default risk.

Question 20

Bonds are immune from most of the types of risk that affect stocks.

Question 21

A note is generally defined as debt with an initial term to maturity of

A) zero to two years.
B) one year or less.
C) two to ten years.
D) ten to thirty years.

Question 22

A single bond issue with multiple maturity dates is called a

A) callable bond.
B) premium bond.
C) serial bond.
D) term bond.

Question 23

Under which bond provision is the issuer required to retire portions of the bond issue prior to maturity?

A) call feature
B) refunding provision
C) subordination clause
D) sinking fund feature

Question 24

The risk premium component of a bond's market interest rate is related to the characteristics of the particular bond and its issuer.

Question 25

Debt instruments with maturities of 2 to 10 years are known as notes.

Question 26

A bond's rating will be affected by bond features as well as by the financial stability of the issuer.

Question 27

Which of the following statements about bond rating agencies is true?

A) Bonds are rated by an agency of the federal government.
B) Bonds rated AAA are guaranteed by the company that issues the rating.
C) During the financial crisis of 2007-2009 it became clear that rating agencies severely underestimated the risks of some issues.
D) Bond rating agencies are paid by investors and receive no compensation from the bonds' issuer.

Question 28

A bond's sinking fund provisions specifies

A) which assets are available to secure the bond.
B) how the issuer will pay off the bond over time.
C) which bond issues have a higher claim on the firm's assets in case the firm goes under.
D) a diminishing series of interest payments as the bond approaches maturity.

Question 29

When a bond is called, the investor faces the prospect of reinvesting the funds at a lower rate.

Question 30

Subordinated debentures

A) have a lower claim on assets than simple debentures.
B) are secured by some physical asset.
C) are financial assets held in trust by a third party.
D) are the safest form of corporate bonds.

Question 31

Lee is considering buying one of two newly-issued bonds. Bond A is a twenty-year, 7.5% coupon bond that is non-callable. Bond B is a twenty-year, 8.25% bond that is callable after two years. Both bonds are comparable in all other aspects. Lee plans on holding his bond to maturity. What should Lee do if he feels that interest rates are going to decline by 2% in the near future and then remain relatively stable thereafter?

A) purchase Bond A
B) purchase Bond B
C) purchase neither A nor B at this time
D) negotiate a higher rate on Bond A

Question 32

Most bonds pay interest quarterly.

Question 33

When a bond's rating changes from AA to A and investors did not anticipate the change

A) the coupon rate will fall and the price will rise.
B) both the coupon rate and the price will rise.
C) the coupon rate will stay the same and the price will fall.
D) the yield and the price will rise.

Question 34

When term bonds are issued, a portion of the bonds will mature at a series of dates rather than all at once.

Question 35

The call feature makes a bond riskier because

A) the issuer may not have sufficient cash to redeem the bonds at the call date.
B) investors who ignore the call will not be paid the bond's principal.
C) after the bond is called, the investor will need to find a new place to invest, probably at a lower rate.
D) the issuer may decided not to call the bond and it will have to be held to maturity or sold in the secondary market.

Question 36

Which of the following are true concerning bond ratings?
I) They have a greater impact on the price and yield of junk bonds than on investment grade bonds.
II) They provide investors with a convenient way to assess the relative risk of various bond issues.
III) They are provided by an independent government agency.
IV) They have a significant effect on a bond's price and yield.

A) I and II only
B) II and IV only
C) III only
D) I, II and IV only

Question 37

Which one of the following is the most junior in terms of its claim on earnings and assets?

A) subordinated debenture
B) mortgage bond
C) collateral trust bond
D) equipment trust certificate

Question 38

Bonds are rated by

A) Moody's.
B) Fitch's.
C) Standard & Poor's.
D) All of the above

Question 39

As a bond approaches maturity, the call premium typically rises.

Question 40

Most bonds pay interest

A) annually.
B) semi-annually.
C) quarterly.
D) monthly.

Question 41

Which of the following factors are included in the rating analysis of a corporate bond?
I) the issue's indenture provisions
II) the liquidity position of the issuing company
III) the issuing company's relative debt burden
IV) the stability of the company's earnings

A) I and II only
B) I, II and III only
C) II, III and IV only
D) I, II, III and IV

Question 42

Which of the following bond features is least desirable to investors?

A) serial maturity dates
B) a nonrefundable provision
C) a call provision
D) sinking fund

Question 43

Bonds with one of the top four ratings (Aaa through Baa, or AAA through BBB) are designated as

A) split bonds.
B) investment grade bonds.
C) illiquid bonds.
D) high-yield bonds.

Question 44

If a bond rating moves from a BB to a BBB rating and investors did not anticipate this rating change

A) the bond will still be classified as junk.
B) it must also move from a Ba to a Baa rating.
C) the market yield on the bond will rise.
D) the market price of the bond will rise.

Question 45

When the market rate of interest is higher than a bond's coupon rate, the bond will sell at a discount.

Question 46

An increase in the market rate of interest can cause a bondholder to realize a capital loss on the sale of their bonds.

Question 47

If you feel interest rates are going to drop significantly, you could potentially realize large capital gains by purchasing long-term zero coupon bonds prior to the rates decreasing.

Question 48

An increase in the market rate of return on an outstanding bond will

A) increase the coupon rate.
B) decrease the coupon rate.
C) increase the bond price.
D) decrease the bond price.

Question 49

The Jefferson Company issued a 5% coupon bond four years ago at par value. The market interest rate on comparable bonds today is 6%. The Jefferson Company bond currently pays a year in interest and the bond sells at a .

A) $60; discount
B) $60; premium
C) $50; discount
D) $50; premium

Question 50

When the economy is moving toward a recession, the yield on riskier bonds will tend to

A) rise.
B) fall.
C) stagnate.
D) become volatile.

Question 51

Every bond is issued with a call feature. Explain what it means for a bond to be "called," then briefly describe the three most common types of call features. Also explain why investors suffer when bonds are called.

Question 52

When interest rates change, the prices of short-term bonds will change more than those of long-term bonds.

Question 53

Which one of the following variables has the greatest effect on bond prices?

A) economic growth
B) interest rates
C) inflation
D) stock market returns

Question 54

Issuers must redeem outstanding bonds for at least their par value.

Question 55

Equinox Corporation issued a 4% bond four years ago at par value. The market interest rate on comparable bonds today is 3.5%.

A) This bond sells at a discount and the coupon rate is higher than the yield.
B) This bond sells at a premium and the coupon rate is lower than the yield.
C) This bond sells at a discount and the coupon rate is lower than the yield.
D) This bond sells at a premium and the coupon rate is higher than the yield.

Question 56

Two years ago, Mathew purchased a 10 year government bond with a yield of 4.75%. Today, the interest rate on government bonds with 8 years to maturity is 3.5%. If Mathew sells his bond today, he most likely will

A) realize a capital gain.
B) realize a capital loss.
C) sell the bond at face value.
D) sell the bond at par value.

Question 57

If you want to reduce the price volatility of your bond portfolio, you should shorten the time- to-maturity of your portfolio.

Question 58

Interest rates and bond prices are positively related.

Question 59

At the time you purchase a bond and assuming all interest payments are made on time, you know the exact holding period return you will earn if

A) the bond is called at any time prior to maturity.
B) you resell the bond in exactly one year from the date of purchase.
C) the market rate of interest declines within the next year.
D) you hold the bond to maturity.

Question 60

Bond ratings are an important element of the bond market. Explain what bond ratings are, who issues the ratings, and what the ratings mean to the average investor.

Question 61

Bob expects to retire in a few years and his primary goal is to avoid major losses in his 401- K account. Which of the following bond characteristics should he be seeking?
I) long maturities
II) high ratings III high yields
IV) short maturities

A) I and III only
B) I, III and III only
C) II and IV only
D) II, III and IV only

Question 62

In an inflationary environment, the interest payments on Treasury inflation-indexed obligations increase over time.

Question 63

If the inflation rate is 2.5%, the principal of a Treasury inflation protection security will from
$1,000 to $1,025.

Question 64

Collateralized mortgage obligations are relatively low risk investments.

Question 65

If you hold a zero-coupon bond Treasury bond to maturity, the fully compounded rate of return is virtually guaranteed to be equal to the rate stated at the time the bond was purchased.

Question 66

When the market rate of return exceeds the coupon rate, a bond will sell at

A) par.
B) face value.
C) a premium.
D) a discount.

Question 67

The par value of a Treasury inflation-indexed obligation is established as $1,000 over the life of the bond.

Question 68

Junk bonds appeal to some investors because of higher yields and potentially higher capital gains than those offered by investment grade bonds.

Question 69

Zero coupon bonds have very limited price volatility.

Question 70

If you expect market interest rates to rise, you should purchase

A) short term, low coupon bonds.
B) short term, high coupon bonds.
C) long term, low coupon bonds.
D) long term, high coupon bonds.

Question 71

Which one of the following statements concerning Treasury bonds is correct?

A) The par values of all Treasury bonds are adjusted periodically in response to changes in the rate of inflation.
B) Treasury bonds have maturity dates ranging from two to ten years.
C) Interest earned on Treasury bonds is tax-exempt at the federal level.
D) All Treasury securities are backed by the "full faith and credit" of the U.S. government.

Question 72

The various CMO tranches can have significantly different degrees of prepayment risk.

Question 73

Which one of the following combination of features causes bond prices to be the most volatile?

A) low coupon, short maturity
B) high coupon, short maturity
C) low coupon, long maturity
D) high coupon, long maturity

Question 74

Securitization is the process of creating marketable securities from various types of loans.

Question 75

Municipal bonds are most attractive to residents of states with high income tax rates.

Question 76

A debenture is secured only by the issuer's promise to repay the debt.

Question 77

A bond quoted at a price of 101.2

A) is a deep discount bond.
B) yields 10.12%.
C) yields 12%.
D) has a coupon rate that exceeds the market rate.

Question 78

Collateralized mortgage obligations (CMOs) have uncertain maturity dates.

Question 79

As bonds approach their maturity dates

A) premiums or discounts will increase.
B) the risk of a call will increase.
C) the bonds prices will become more sensitive to changes in interest rates.
D) prices will approach their par values.

Question 80

CMO tranches are structured to create long, intermediate and short-term securities.