Deck 8: Bond Markets

Question 1

Most state and local government bonds are sold to finance education.

Answer 1

True

Question 2

A serial bond issue matures over a period of years.

Answer 2

True

Question 3

The money market provides liquidity for deficit units; the capital market finances economic growth.

Answer 3

True

Question 4

Financial institutions and households own about the same amount of financial assets.

Question 5

Life insurance companies are more likely to invest in corporate capital market securities than commercial banks.

Question 6

A U.S. Treasury STRIP is a zero-coupon bond.

Question 7

Money market securities are all debt securities, while capital market securities are either debt or equity securities.

Question 8

Investors may invest in capital market securities either directly or indirectly.

Question 9

Households are the major investor in municipal bonds.

Question 10

A state turnpike authority is more likely to issue revenue bonds than general obligation bonds.

Question 11

Yields on U.S. Treasury "ask" prices are higher than yields quoted on "bid" prices.

Question 12

Households owe more financially than they own.

Question 13

TIPS protect investors primarily from default risk.

Question 14

Capital market interest rates tend to be higher than money market rates for a given issuer.

Question 15

Lower marginal tax rates increase the demand for tax-exempt securities.

Question 16

The primary market for junk bonds expanded for higher risk firms as the secondary market for junk bonds developed.

Question 17

Capital market securities are used to finance real capital investments.

Question 18

The volume of mortgages outstanding exceeds the volume of corporate bonds in the U.S.

Question 19

Both governments and businesses issue both debt and equity capital market securities.

Question 20

Capital market securities are more liquid than money market securities.

Question 21

Most general obligation bonds are sold through

A) direct placement.
B) negotiated bids.
C) competitive bids.
D) private placement.

Question 22

The length of the maturity on a bond offering affects its cost. In general, the longer the maturity, the higher the cost.

Question 23

Which of the following statements about STRIPs is true?

A) STRIPs are sold directly by the Treasury Department
B) When a STRIP is created, all interest payments become one security and the principal payment becomes the other.
C) Many small investors prefer STRIPs because they require a lower minimum investment than original Treasury notes and bonds.
D) Treasury securities dealers create STRIPs because they expect to sell the created zero-coupon securities for more than what they paid for the original Treasury security.
E) None of the above statements is true.

Question 24

A capital market financing is most likely to finance

A) new plant and equipment.
B) seasonal inventory needs.
C) a quarterly dividend payment.
D) the sale of common stock.

Question 25

The yield on a three-year Treasury note is 4.5% and the yield on a three-year TIPS is 2.4%. What is the market's estimate of the annual inflation rate over the next three years?

A) 1.1%
B) 1.6%
C) 4.5%
D) 2.4%
E) 2.1%

Question 26

TIPS have less _____ risk than "regular" Treasury securities of the same maturity.

A) default
B) price
C) liquidity
D) foreign exchange

Question 27

The fastest growing debt sector in the U. S. is

A) Treasury debt
B) federal agency debt
C) mortgage debt
D) corporate debt

Question 28

Investors in U.S. Treasury STRIPs are primarily interested in eliminating which of the following bond investor risks?

A) default risk
B) price risk
C) reinvestment risk
D) foreign exchange risk

Question 29

Callable bonds are the bonds that can be redeemed at par at the option of their holders either at specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt are called.

Question 30

Commercial banks purchase more tax-exempt securities when loan losses increase.

Question 31

The after-tax return on a 9 percent tax-exempt municipal bond to a commercial bank in the 34 percent tax bracket is 5.94 percent.

Question 32

Revenue bonds are generally considered more risky than general obligation bonds.

Question 33

The biggest supplier of funds in the capital markets are

A) financial institutions
B) state and local governments
C) federal government
D) households and non-profit organizations

Question 34

The secondary markets for capital market securities have facilitated economic growth in the U.S. because

A) they help provide marketability for capital market claims.
B) they have increased people's willingness to buy capital market claims.
C) they make people more willing to invest because they can more easily diversify their risk.
D) all of the above

Question 35

Which of the following is not an example of capital market securities?

A) common stocks
B) convertible bonds
C) commercial paper
D) mortgages

Question 36

Bondholders will NOT convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock.

Question 37

The conversion feature of a bond is to give the issuer the opportunity to repurchase bonds at a stated price prior to maturity.

Question 38

Capital market borrowing by businesses is generally repaid from the cash flow generated by the assets financed.

Question 39

You purchase a Treasury inflation-protected note with an original principal amount of $1,000,000 and a 2.8 percent annual coupon (paid semiannually). What will the first coupon payment be if the semiannual inflation over the first six months is 1.2%?

A) $14,168
B) $14,000
C) $28,336
D) $28,000
E) $12,336

Question 40

One of the fastest growing loan areas for commercial banks in the 1980s was financial guarantees.

Question 41

The quality of a financial guarantee depends on the reputation and financial strength of the

A) guarantor
B) investor
C) borrower
D) none of the above

Question 42

Everything else being equal, a bond will sell at a higher yield if it

A) has a call provision.
B) has low default risk.
C) can be converted to stock.
D) is listed on an exchange.

Question 43

The demand for junk bonds came primarily from

A) life insurance companies
B) savings & loans association
C) pension funds
D) all of the above

Question 44

Which of the following terms is not commonly associated with municipal bonds?

A) inflation-protected bonds
B) serial bonds
C) general obligation bonds
D) revenue bonds

Question 45

If average corporate bond and tax-exempt municipal bond rates were 8.33% and 6.25% respectively, an investor in the 34 percent marginal corporate tax bracket would purchase

A) the tax-exempt bond.
B) the corporate bond.
C) either security (i.e., the investor is indifferent)
D) the security with the higher pre-tax yield.
E) both a and d

Question 46

Securitization of loan portfolios, such as credit card loans and mortgage loans, will occur if

A) the financial market will pay more for the loan portfolio than the issued asset- backed securities.
B) the financial market will pay more for the issued asset-backed securities than the loan portfolio.
C) a financial guarantee is obtained from a commercial bank.
D) the borrowers permit their loan to be securitized.
E) both a and d

Question 47

Life insurance companies and pension funds buy corporate bonds for which two major reasons?

A) tax sheltering and high yield
B) liquidity and high after-tax returns
C) liability maturity matching and high after-tax returns
D) low risk and liquidity

Question 48

31 The incentive to securitize a portfolio of loans is

A) the profit from the loan revenue.
B) the profit from the interest on the asset-backed securities issued.
C) the profit from the fees paid for financial guarantees.
D) the profit from the difference between the loan revenue and the costs of guarantees and return on the asset-backed securities.

Question 49

Letters of credit are mostly associated with

A) financial guarantees.
B) investment banking.
C) a bond indenture.
D) a commercial bank seasonal loan.

Question 50

Credit-rating agency ratings are associated with which of the following investor risks?

A) interest rate risk
B) default risk
C) purchasing power risk
D) reinvestment risk
E) exchange rate risk

Question 51

In the primary market, corporate bonds cannot be sold through

A) securities exchanges such as NYSE
B) competitive sales
C) negotiated sales
D) private placement

Question 52

The largest investor in municipal bonds are

A) property and casualty insurance companies
B) commercial banks
C) households
D) mutual funds
E) pension funds

Question 53

Which of the following would be least likely to purchase a tax-exempt municipal bond?

A) commercial bank
B) casualty insurance company
C) mutual fund
D) individuals in low tax brackets

Question 54

In the 1980s, low credit quality businesses were able to first issue their new bond securities in which market?

A) municipal bond market
B) junk bond market
C) investment-grade bond market
D) secondary market
E) subprime mortgage market

Question 55

Corporate bonds are less marketable than money market instruments and corporate equities because

A) they have special features (e.g., call provisions) that make them difficult to value.
B) they are long-term securities, which tend to be riskier and less marketable.
C) both a and b
D) Corporate bonds are in fact not less marketable than money market instruments and corporate equities.

Question 56

Industrial development bonds (IDBs) are debt securities issued by:

A) the federal government
B) non profit organizations
C) state and local government agencies
D) nonfinancial businesses.

Question 57

Which of the following is not a difference between municipal bonds (munis) and corporate bonds?

A) Interest paid on munis is tax-exempt, while interest paid on corporate bonds is not.
B) Munis often have a range of maturities (are serial issues) but corporate bonds do not.
C) Unlike corporate bonds, munis are rated by bond-rating agencies such as Moody's.
D) All of the above are differences between munis and corporate bonds.

Question 58

An investor in the 34 percent federal tax bracket would probably select what investment (all with similar default risk)?

A) 7% municipal bond
B) 10% corporate bond
C) 11% mortgage
D) 9% Treasury bond

Question 59

All of the following bond terms relate to maturity except

A) serial.
B) debenture.
C) sinking fund.
D) call provision.

Question 60

If average corporate bond and tax-exempt municipal bond rates were 8.33% and 6.25% respectively, at what marginal tax rate would an investor be indifferent between the two?

A) 18%
B) 25%
C) 30%
D) 33%
E) 35%

Question 61

Bonds issued by foreign entities in the United States are called:

A) foreign bonds
B) American depository receipts
C) Yankee bonds
D) Samurai bonds

Question 62

What might determine whether an individual investor buys corporate or municipal bonds? Give an example.

Question 63

U.S. Treasury STRIPs are of interest to individuals with IRA's or $401k pension plans. Why?

Question 64

What factors have contributed to the increased globalization of bond markets?

Question 65

The most important regulator in the U.S. capital markets is the

A) Federal Reserve System
B) Treasury Department
C) National Association of Security Dealers (NASD)
D) Federal Deposit Insurance Corporation
E) Securities and Exchange Commission

Question 66

Which of the following is NOT associated with credit enhancements for asset-backed securities?

A) Cash-collateral accounts that are deposits set aside to cover losses
B) Financial guarantees from bond insurance companies
C) Standby letters of credit from major commercial banks
D) A guarantee to pay from the borrowers

Question 67

All but one of the following may be associated with the increased globalization of bond markets:

A) the globalization of business activity
B) increased volatility in foreign exchange rates
C) Improved computer and telecommunications technology
D) the reduction in trade barriers and standardization of regulations.

Question 68

Which one of the following bonds is likely to have the highest required rate of return, ceteris paribus?

A) AAA rated noncallable corporate bond with a sinking fund.
B) AA rated callable corporate bond without a sinking fund
C) AA rated callable corporate bond with a sinking fund
D) AAA rated callable corporate bond with a sinking fund
ESSAY QUESTIONS

Question 69

Compare and contrast the characteristics of the securities of the money market with those of the capital market.

Question 70

List the risks faced by bond investors.

Question 71

You check Wall Street Journal and find information regarding a principal STRIP that will mature in 7 years. The price quote per hundred of par for this STRIP is 85.75%. Using semiannual compounding, what is the promised yield to maturity on the STRIP?