Deck 10: Fixed-Income Securities

Question 1

Bonds are typically a good investment choice for an individual who is seeking long-term preservation of capital.

Answer 1

True

Question 2

the phenomenon known as "flight to quality" causes yields on government bond and corporate bonds

A) to rise in tandem.
B) to fall in tandem.
C) to move in opposite directions.
D) to become less volatile.

Answer 2

C

Question 3

Bondholders can earn income both from interest and from capital gains.

Answer 3

True

Question 4

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

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

Question 5

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 6

Each interest payment on a 6%, semi-annual bond is $30.

Question 7

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

Question 8

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 9

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

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

Question 10

During the period 2008 through 2012, bonds performed poorly because of falling interest rates.

Question 11

Over the period from late 2008 through 2012, the bond market outperformed the stock market.

Question 12

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 13

Each interest payment on a 6%, semi-annual bond is $60.

Question 14

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

Question 15

When interest rates are falling, most of the return on bonds will come from

A) inflation gains.
B) interest income.
C) capital gains.
D) risk premiums.

Question 16

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 17

As investors approach retirement age, they should hold more bonds and less stock.

Question 18

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

Question 19

Corporate bonds are actively traded in the secondary markets.

Question 20

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 21

The initial call price of an 8% bond could be as high as $1,080.

Question 22

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 23

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 24

Bonds issued by stable sovereign governments such as the U.S. and the nations of Western Europe

A) are rated AAA by definition.
B) can be and have been downgraded.
C) are exempt from rating requirements.
D) are allowed to issue their own ratings.

Question 25

A bond which is noncallable for a period of time after which it is freely callable is called a deferred call bond.

Question 26

Which of the following is(are) senior bonds?
I) equipment trust certificates
II) mortgage bonds
III) debentures
IV) collateral trust bonds

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

Question 27

Debentures are secured by

A) the issuer's good name.
B) earnings from the project the debentures were issued to finance.
C) financial assets held in trust by a third party.
D) physical assets like real estate.

Question 28

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 29

Most bonds pay interest

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

Question 30

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 31

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

Question 32

A bond which has a deferred call

A) does not have to be redeemed when it reaches maturity.
B) can be retired at any time prior to maturity provided six months notice is given.
C) cannot be retired for a specific period of time after which it can be retired at any time.
D) can be retired at any time during the initial call period but after that time can not be redeemed prior to maturity.

Question 33

A single bond issue with multiple maturity dates is called a

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

Question 34

When a bond is called, the bondholder generally faces a rate of return that is lower than expected.

Question 35

Most bonds pay interest quarterly.

Question 36

When a bond's rating improves from A to AA

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

Question 37

Bonds are least likely to be called if

A) they are selling at a substantial premium.
B) they are selling at a substantial discount.
C) the price is close to par value.
D) if they do not mature for at least 5 years.

Question 38

The holder of a serial bond receives both semi-annual interest and principal payments over the life of the bond.

Question 39

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 40

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

Question 41

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 42

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 43

Which of the following will tend to improve a bond's rating?
I) an improvement in the firm's cash flow
II) an increase in corporate debt
III) an increase in net profits
IV) an increase in net working capital

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

Question 44

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

Question 45

The Franklin Company issued a 6% bond three years ago at par value. The market interest rate on comparable bonds today is 5%. The Franklin 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 46

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

Question 47

Solstice Corporation issued a 5% bond four years ago at par value. The market interest rate on comparable bonds today is 4%.

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 48

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 49

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 50

Investment-grade bonds are more interest rate sensitive than junk bonds.

Question 51

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 52

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

Question 53

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 54

If a bond rating moves from a BB to a BBB rating

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 55

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 56

Fixed coupon rates cause bond yields to lag inflation rates when inflation rates begin to increase significantly.

Question 57

Interest rates and bond prices are positively related.

Question 58

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

Question 59

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 60

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 61

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

Question 62

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 63

If you hold a zero-coupon 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 64

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 65

If the inflation rate is 2%, the principal of a Treasury inflation protection security will from $1,000 to $1,020.

Question 66

At the time you purchase a bond, 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 67

Collateralized mortgage obligations are relatively low risk investments.

Question 68

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

Question 69

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

Question 70

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

Question 71

Mortgage-backed securities are self-liquidating.

Question 72

Zero coupon bonds have very limited price volatility.

Question 73

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 74

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 75

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

Question 76

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

Question 77

Junk bond prices tend to be volatile just like common stock prices.

Question 78

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

A) The coupon rate of a TIPS is 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 79

Mortgage-backed bonds are issued primarily by state governments and are secured by home mortgages.

Question 80

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