Deck 10: Fixed-Income Securities

Question 1

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.

Answer 1

C

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

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.

Answer 3

D

Question 4

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

Question 5

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 6

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 7

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

Question 8

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

Question 9

Bondholders usually have capital gains when interest rates are rising.

Question 10

A coupon rate of 6% means that the bond will pay $60 interest every 6 months if interest is paid semi-annually.

Question 11

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

Question 12

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

Question 13

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 14

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

Question 15

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

Question 16

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

Question 17

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 18

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

Question 19

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 20

Bond investors will experience capital gains when

A)market interest rates are high and falling.
B)market interest rates are high and 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 21

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 22

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 23

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

Question 24

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 25

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 26

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 27

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

Question 28

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 29

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

Question 30

Most bonds pay interest quarterly.

Question 31

The interest payment on a 6% coupon, semi-annual bond is $30 every 6 months.

Question 32

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 33

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

Question 34

Most bonds pay interest

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

Question 35

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

Question 36

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 37

A single bond issue with multiple maturity dates is called a

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

Question 38

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

Question 39

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 40

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 41

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 42

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

Question 43

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 44

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 45

When the market rate of interest drops below a bond's coupon rate, the bond will sell at a 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

Junk bond prices are more sensitive to ratings changes than investment grade bonds.

Question 48

Solstice Corporation issued a 3% 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 49

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

Question 50

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 51

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 52

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 53

Interest rates and bond prices are positively related.

Question 54

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 55

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

Question 56

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 57

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 58

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 59

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 60

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 61

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

Question 62

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

Question 63

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

Question 64

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 65

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 66

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

Question 67

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

Question 68

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

Question 69

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

Question 70

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 71

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

Question 72

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 73

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

Question 74

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 75

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 76

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 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

Zero coupon bonds have very limited price volatility.

Question 79

Collateralized mortgage obligations are relatively low risk investments.

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