Deck 11: Bond and Fixed-Income Fundamentals

Question 1

An important feature of the GNMA (GinnieMae) pass-through certificate is that there is no principal balance at maturity.

Answer 1

True
Explanation: A major consideration in this investment is that the investor has fully consumed his or her capital at the end of the investment. (Not only has interest been received monthly but also all principal has been returned over the life of the certificate, and therefore, there is no lump-sum payment at maturity.)

Question 2

Changes in the market rate of interest are reflected in the semiannual interest payments of a variable rate note, while the price remains stable.

Answer 2

True
Explanation: A few corporate bonds are termed variable-rate notes or floating-rate notes, meaning the coupon rate is fixed for only a short period and then varies with a stipulated short-term rate, such as the rate on U.S. Treasury bills. In this instance, the interest payment, rather than the price of the bond, varies up and down.

Question 3

A secured corporate bond is referred to as a debenture.

Answer 3

False
Explanation: A corporate debt issue that is unsecured is referred to as a debenture.

Question 4

An investor in a municipal bond will receive 8% interest. He is in a 33% tax bracket. The comparable before-tax yield on a taxable investment is 14%.

Question 5

Income bonds are highly favored by corporations, because they provide the benefits of tax-deductible interest payments, without the contractual obligations of most debt instruments.

Question 6

Like the stock market, there is a strong secondary market for bond issues, particularly corporate and municipal bonds.

Question 7

The major provisions in the bond agreement are spelled out in the bond debenture.

Question 8

Preferred stock dividends are tax-deductible to the corporation, and also provide tax advantages to the corporate investor.

Question 9

Corporate bonds carry a higher yield than government issues, and are fully taxable for federal, state, and local purposes.

Question 10

A sinking fund may be used to pay off a perpetual bond.

Question 11

While the stock market has an active secondary market, the bond market consists primarily of investors who buy and hold bond issues to maturity.

Question 12

A Treasury bill is a long-term obligation of the federal government.

Question 13

Corporate issues make up the largest percentage of new debt offerings in the bond market.

Question 14

An after-acquired clause requires that new property must be placed under the original mortgage.

Question 15

A call provision allows the corporation to retire a bond before maturity by paying a small discount below par value.

Question 16

The IRS taxes zero-coupon bonds as if interest were paid annually, even though no cash flow is received until maturity.

Question 17

The dollar volume of new corporate debt issues has exceeded the dollar volume of new corporate equity issues for many years.

Question 18

Income bonds specify that interest is to be paid only to the extent that it is earned in current income.

Question 19

Interest and capital gains on municipal bonds are tax-exempt by the IRS.

Question 20

Interest on federally-sponsored credit agency issues (such as the Federal Home Loan Bank) is not tax-free to the recipient.

Question 21

Yankee bonds are issued by foreign governments, corporations, or are traded in the U.S. and denominated (payable) in U.S. dollars.

Question 22

In many respects, the bond market appears to demonstrate a high degree of rationality of risk and return.

Question 23

The higher the bond rating of a corporation, the higher the interest rate that is likely to be paid.

Question 24

Large or jumbo CDs are $100,000 or greater in size.

Question 25

Which of the following types of bond issues is the most price-sensitive?

A)Fixed-rate long-term bonds
B)Floating-rate bonds
C)Long-term zero-coupon bonds
D)Fixed-rate short-term bonds
E)Treasury bills

Question 26

There is evidence that the bond market may be less efficient than the stock market.

Question 27

A split rating means that bond-rating agencies assigned different ratings.

Question 28

A legal document which is administered by an independent trustee and spells out the major provisions of a bond agreement is called the

A)bond contract.
B)bond indenture.
C)debenture.
D)bond subordination.

Question 29

While Treasury bonds and bills are quoted on the basis of price, Treasury notes are quoted on the basis of yield.

Question 30

The bond market is dominated by institutional investors.

Question 31

Foreign bonds normally provide:

A)higher yields than U.S. bonds.
B)lower yields than U.S. bonds.
C)diversification benefits.
D)None of the above

Question 32

A Treasury note normally has a maturity of:

A)less than one year.
B)1 to 5 years.
C)1 to 10 years.
D)10 to 30 years.
E)30 to 100 years.

Question 33

A corporation must generally pay taxes on only 30% of the dividends (preferred or common) that it receives from another corporation.

Question 34

Foreign-pay bonds are issued in a foreign country and are payable in U.S. dollars.

Question 35

Money market funds represent a vehicle to buy short-term fixed-income securities through a mutual fund arrangement.

Question 36

Commercial paper represents a short-term credit instrument.

Question 37

The bond market investor must be prepared to deal in a relatively strong primary market (new issues market) and a relatively weak secondary market (resale market).

Question 38

As the yield spread between high and low rating categories increases, this indicates a gain of confidence in the economy.

Question 39

A bond quote of 91 7/8 on a $1,000 par value bond means the bond is trading at $918.75.

Question 40

Private placements refer exclusively to stock issues sold to insurance companies or individuals.

Question 41

A bond with a put provision allows the investor to:

A)convert the bond to a specified number of shares of common stock.
B)sell the bond back to the corporation at a small premium over par at a specified time period.
C)sell the bond back to the corporation at par at a specified time period.
D)receive additional interest payments if inflation goes above a specified level.

Question 42

Municipal bonds normally pay:

A)higher rates than taxable bonds.
B)lower rates than taxable bonds.
C)the same rate as taxable bonds.
D)None of the above

Question 43

Securities issued by the Federal Farm Credit Bank

A)are essentially risk-free.
B)carry a higher yield than U.S. Treasury securities.
C)are fully taxable by federal, state, and local governments.
D)All of the above

Question 44

Which of the following statements about U.S. Treasury securities is true?

A)The interest earned on Treasury bills is fully taxable by states
B)All Treasury securities are considered to be risk-free
C)The maturities of Treasury bills, notes, and bonds tend to be different
D)More than one of the above is true

Question 45

The largest segment of the corporate bond market consists of

A)public utilities.
B)rails and transportation.
C)financial issues.
D)industrial issues.

Question 46

Junk bonds normally provide:

A)a higher yield than Treasury bonds.
B)a lower yield than Treasury bonds.
C)a lower yield than AA corporate bonds.
D)More than one of the above is true

Question 47

For the major bond-rating agencies, the lowest level of an investment grade bond is:

A)AA (investment grade includes AAA and AA).
B)A (investment grade includes AAA, AA and A).
C)BBB (investment grade includes AAA, AA, A, and BBB).
D)B (investment grade includes AAA, AA, A, BBB, BB and B).

Question 48

A strong incentive to a corporation to meet preferred stock dividend payments is provided by the ___________ feature of some preferred stocks.

A)Cumulative
B)Convertible
C)Callable
D)All of the above

Question 49

The primary difference between large (jumbo) and small Certificates of Deposit, besides dollar amount, is:

A)that jumbo certificates have a variable interest rate.
B)that small certificates are considered to be risk-free.
C)that there is no secondary market for small certificates of deposit.
D)None of the above

Question 50

A provision in which semiannual or annual contributions are made by a corporation into a fund administered by a trustee for purposes of debt retirement is referred to as a:

A)call provision.
B)put provision.
C)sinking-fund provision.
D)serial payment.

Question 51

A call feature may be valuable to:

A)investors.
B)the issuing company.
C)corporate employers.
D)the IRS.

Question 52

The difference between a general obligation and a revenue bond is:

A)the general obligation bond is backed by the full faith, credit, and "taxing power" of the governmental unit.
B)that for a revenue bond, the repayment of the issue is fully dependent on the revenue-generating capability of a specific project or venture.
C)that general obligation bonds are usually of high quality because of the taxing power behind most of them.
D)All of the above

Question 53

The most important feature of municipal bonds is:

A)the wide range of denominations and maturities.
B)that the interest is not taxable by the federal government.
C)the risk-free nature of this investment.
D)its appeal to investors needing growth.

Question 54

All of the following are available to individual investors except:

A)commercial paper.
B)bankers' acceptances.
C)money market funds.
D)All of the above are available to individual investors

Question 55

The demand side of the bond market is dominated by

A)the federal government.
B)wealthy individual investors.
C)institutional investors.
D)None of the above

Question 56

Which of the following is NOT a characteristic of preferred stock as an investment?

A)Preferred stockholders are entitled to receive their dividend prior to payment of dividends to common stockholders
B)Preferred stock dividends are taxed at the capital gains rate for individual investors
C)Preferred stock dividends may be omitted by the corporation under certain circumstances
D)It is a hybrid security of common stock and debt

Question 57

Public utility issues have a greater yield than other corporate issues, primarily because:

A)nuclear utility issues carry an extremely high risk premium.
B)public utility issues generally have a longer maturity.
C)investor demand for utility issues is greater than for other issues.
D)utilities' demands for funds is greater than that of other segments.

Question 58

An example of secured debt would be a:

A)contract where two signatures specified how the contract would be paid.
B)contract in which a court kept the contract in its possession to see that nothing would happen to it.
C)contract in which real assets are pledged as security for a loan.
D)debenture.

Question 59

Treasury strips provide return through:

A)increase in value over their life.
B)high-dividend yields.
C)indexing for inflation.
D)changing par value with the passage of time.

Question 60

There is customarily a small spread between bid and asked prices of Treasury notes and bonds, because:

A)they are traded at a discount from par.
B)there is competition from other markets.
C)the market for Treasury issues is liquid.
D)there are not many government securities dealers.

Question 61

Assume a $1,000 Treasury bill is quoted to pay 6% interest over a three-month period. How much interest would the investor receive?

A)$10
B)$15
C)$20
D)$30
E)$60

Question 62

Inflation-indexed Treasury securities provide returns through:

A)interest payments, plus a conversion privilege.
B)interest payments, plus an increase in value due to inflation.
C)tax-exempt interest payments.
D)cumulative interest payments.

Question 63

Assume a $1,000 Treasury bill is quoted to pay 6% interest over a three-month period. What will be the price of the Treasury bill?

A)$940
B)$970
C)$980
D)$985
E)$990

Question 64

Assume a $1,000 Treasury bill is quoted to pay 10% and matures in 3 months.
a) How much interest would an investor receive?
b) What will be the price of the Treasury bill?
c) What will be the true rate of return?

Question 65

Assume a $1,000 Treasury bill is quoted to pay 6% interest over a three-month period. What will be the effective yield?

A)6.09%
B)6.38%
C)3.05%
D)25.53%
E)1.53%

Question 66

A corporate bond quoted at 108.25 is selling for:

A)$108.25.
B)$1,082.50.
C)$10,825.
D)None of the above

Question 67

Corporate bonds generally trade in units of:

A)$100.
B)$1,000.
C)$5,000.
D)$10,000.

Question 68

The junk bond market includes all of the following except:

A)fallen angels.
B)profitable companies undergoing expansion.
C)growth companies (small firms not that well established, making them unable to receive an investment quality rating).
D)companies undergoing restructuring because of a leveraged buyout (LBO) or unfriendly takeover.

Question 69

If an investor is in the 33% marginal tax bracket and can purchase a municipal bond paying 7.5%, what would the equivalent before-tax return from a corporate bond have to be to equate the two returns on a before-tax basis?

Question 70

If inflation is higher than that expected at time of issue, inflation-indexed Treasury securities:

A)provide a lower return than fixed-income securities.
B)provide a higher return than fixed-income securities.
C)do not adequately compensate the investor for loss of purchasing power.
D)may be called in by the government.

Question 71

What is the dollar value of a U.S. government bond quoted at 98 8/32?

Question 72

Major investors in municipal bonds include:

A)banks.
B)pension funds.
C)wealthy individuals.
D)A and C

Question 73

Assume a $1,000 Treasury bill is quoted to pay 9.5% interest over a six-month period.
a) How much interest would an investor receive?
b) What will be the price of the Treasury bill?
c) What will be the true rate of return?