Free Printable FIN 2302: Bond notes, security business, and time value

1.

These agencies provide a valuable service to the financial industry called Securitization.

a)

minimize the interest rate risk and to bring the million dollars back to the bank to make more loans.

b)

As people make their mortgage payments, the money passes to the bondholder (principal and interest).

c)

this is the act of making an investment security out of something that isn't; and in doing so, they bring liquidity to financial firms.

d)

They pay a higher rate of interest than many other debt securities, have 30-year terms and are backed by a Federal Agency (FNMA).

2.

The Federal National Mortgage Association (FNMA, called "Fannie Mae")

a)

The bank will immediately sell the loans to minimize the interest rate risk and to bring the million dollars back to the bank to make more loans.

b)

They pay a higher rate of interest than many other debt securities, have 30-year terms and are backed by a Federal Agency (FNMA).

c)

These agencies provide a valuable service to the financial industry called Securitization.

d)

The risk that interest rates will rise, moving the rate on short-term deposits up beyond the rate the mortgage loan is earning.

3.

Mortgage Backed Securities.

a)

The bank uses federal agencies to minimize the interest rate risk that is inherent in mortgage lending.

b)

The bank is concerned about interest rate risk.

c)

This is the act of making an investment security out of something that isn't; and in doing so, they bring liquidity to financial firms.

d)

They pay a higher rate of interest than many other debt securities, have 30-year terms and are backed by a Federal Agency (FNMA).

4.

Federal agencies

a)

The Federal National Mortgage Association (FNMA, called "Fannie Mae")

b)

The Government National Mortgage Association (GNMA, Ginnie Mae)

c)

The Student Loan Marketing Association (SLMA, Sallie Mae)

d)

All of them

5.

The Student Loan Marketing Association (SLMA, Sallie Mae)

a)

who securitizes mortgages, just like Fannie Mae.

b)

who securitizes government guaranteed student loans.

c)

we called this the Savings & Loan crises in the 1980's.

d)

The bank is concerned about interest rate risk.

6.

The Government National Mortgage Association (GNMA, Ginnie Mae)

a)

who securitizes mortgages, just like Fannie Mae.

b)

The hypothetical yield curve is a "line-of-best-fit" drawn through different interest-maturity combinations.

c)

There is a 3.15% spread between the two. The larger the spread, the steeper the curve

d)

who securitizes government guaranteed student loans.

7.

The (a) yield curve is a "line-of-best-fit" drawn through different interest-maturity combinations.

8.

The Yield Curve (or the "Term Structure of Interest Rates")

a)

they do not pre-pay their mortgages but hold them for as long as they can.

b)

who securitizes government guaranteed student loans.

c)

is a graphical relationship of interest rates and terms of maturity for fixed income products.

9.

A "typical, normal" yield curve is a graph that is _________, to the ______

a)

upward sloping; right

b)

Right side; left side

c)

downward sloping; left

10.

Whenever the US Government borrows money, the bonds, notes and bills are

a)

auctioned usually to large banks and brokerage firms.

b)

now taking the interest rate risk.

c)

As people make their mortgage payments, the money passes to the bondholder (principal and interest).

11.

The price and yield that wins the auction sets the rate.

a)

True

b)

False

12.

The ______ the credit rating, the ______ interest rates that they have to pay.

a)

higher; lower

b)

lower; higher

13.

The larger the spread, the steeper the curve.

a)

False

b)

True

14.

Shape of the Yield Curve

a)

Rational Expectations Theory

b)

Liquidity Preference Theory

c)

Market Segmentation Theory

d)

All of the above

15.

Rational Expectations Theory

a)

[A little tougher to understand] An investor will sacrifice a higher yield for a lower yield by lending short term instead of long term. An investor will pay a higher price (and accept a lower yield) to have a shorter term, more liquid security. Thus a 'liquidity preference.'

b)

{The toughest one} This theory asserts that the yield curve is not smooth and continuous but exists as broken segments, each with their own set of terms and rates. Businesses operate in certain areas of the curve. Banks, for example, tend to prefer to lend money short term, and borrow short term. Insurance companies have products (like life insurance) that are primarily long-term in nature, other companies tend to buy and sell securities in the "middle" of the curve. Market Segmentation states that the "segments" are independent of each other.

c)

(The easiest, most strait forward of the theories) This theory states that investors expect to be paid a higher interest rate when investing for a longer term. This is the most plausible, most referenced theory of the yield curve's shape. To "go out on the curve" means purchasing longer termed securities and to do so invites more risk.

16.

Liquidity Preference Theory

a)

{The toughest one} This theory asserts that the yield curve is not smooth and continuous but exists as broken segments, each with their own set of terms and rates. Businesses operate in certain areas of the curve. Banks, for example, tend to prefer to lend money short term, and borrow short term. Insurance companies have products (like life insurance) that are primarily long-term in nature, other companies tend to buy and sell securities in the "middle" of the curve. Market Segmentation states that the "segments" are independent of each other.

b)

[A little tougher to understand] An investor will sacrifice a higher yield for a lower yield by lending short term instead of long term. An investor will pay a higher price (and accept a lower yield) to have a shorter term, more liquid security. Thus a 'liquidity preference.'

c)

(The easiest, most strait forward of the theories) This theory states that investors expect to be paid a higher interest rate when investing for a longer term. This is the most plausible, most referenced theory of the yield curve's shape. To "go out on the curve" means purchasing longer termed securities and to do so invites more risk.

17.

{The toughest one} This theory asserts that the yield curve is not smooth and continuous but exists as broken segments, each with their own set of terms and rates. Businesses operate in certain areas of the curve. Banks, for example, tend to prefer to lend money short term, and borrow short term. Insurance companies have products (like life insurance) that are primarily long-term in nature, other companies tend to buy and sell securities in the "middle" of the curve. Market Segmentation states that the "segments" are independent of each other.

a)

Rational Expectations Theory

b)

Market Segmentation Theory

c)

Rational Expectations Theory

18.

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

a)

true

b)

false

19.

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

a)

true

b)

false

20.

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

a)

true

b)

false

21.

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

a)

true

b)

false

22.

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

a)

true

b)

false

23.

A secured corporate bond is referred to as a debenture.

a)

true

b)

false

24.

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

a)

true

b)

false

25.

The Federal Reserve Board of Governors controls money supply and interest rates through its monetary policy.

a)

true

b)

false

26.

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

a)

true

b)

false

27.

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

a)

true

b)

false

28.

Which of the following types of bond issues are the most price sensitive?

a)

Fixed rate long-term bonds

b)

Floating rate bonds

c)

Zero coupon bonds

d)

Fixed rate short-term bonds

29.

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

30.

A call feature may be valuable to:

a)

Investor

b)

the issuing company

c)

corporate employers

d)

the IRS

31.

Corporate bonds generally trade in units of

a)

$100

b)

$1,000

c)

$10,000

d)

$5,000

32.

The investment bank will buy all of the securities that the firm wants to sell for a predetermined price. They advertise these deals in major financial publications such as the Wall Street Journal by placing an ad (called a tombstone ad).

a)

true

b)

false

33.

Primary markets

a)

which is a group of investment bankers helping with the transaction. The lead firm is the syndicate manager.

b)

provide a forum for the trading of securities after their initial sale; a stock exchange.

c)

Involve the sale of new securities, ones that are coming from the issuing corporation to the investment bank.

d)

Companies issue new securities

34.

Secondary markets

a)

which is a group of investment bankers helping with the transaction. The lead firm is the syndicate manager.

b)

Involve the sale of new securities, ones that are coming from the issuing corporation to the investment bank.

c)

provide a forum for the trading of securities after their initial sale; a stock exchange.

35.

(Direct Placement - The issuing firm sells shares directly to institutional investors bypassing the underwriters. The firm saves fees and the purchasing institution gets better rates. In a syndicated method, shares are to be sold to individuals. Un-syndicated means institutions buy for themselves.

a)

Un-syndicated Stock Offering

b)

Standby

c)

Secondary Distributors

d)

Best Effort Underwriting

36.

Investment Banker provides a best effort at selling the entire issue. The remainder is repurchased by the firm.

a)

Standby

b)

Secondary Distributors

c)

Un-syndicated Stock Offering

d)

Best Effort Underwriting

37.

Underwriters standby as firm does issuing. Underwriters will assume leftovers.

a)

Secondary Distributors

b)

Standby

c)

Un-syndicated Stock Offering

d)

Best Effort Underwriting

38.

Say that a Mutual Fund or wealthy individual wants to unload large number of shares and they need help selling. They would turn to a secondary distributor to place the shares in the market without depressing the price while doing so.

a)

Best Effort Underwriting

b)

Secondary Distributors

c)

Un-syndicated Stock Offering

d)

Standby

39.

Stock Exchanges exist as an insufficient mechanism to exchange securities among investors.

a)

true

b)

false

40.

Does the secondary market need to be represented by brokers who execute trades?

a)

true

b)

false

41.

Two different brokerage firms:

a)

credit firm

b)

full-service firm

c)

personal firm

d)

discount firm

42.

full-service firm and discount firm become a one-stop-financial-shops for individual investors?

a)

true

b)

false

43.

The difference between a full-service firm and a discount firm is (a)

44.

Margin is (a)

45.

LONG means you own it, and if you sell it, you no longer own it. If they were to sell the GM stock that they have, they would (1) no longer be long GM, and they would have (2) completed a 'round trip.'

a)

true

b)

false

46.

The most common order. Buy or sell at current "market" price. This order implicitly instructs the broker to purchase or sell the security as quickly as possible. That you are "not concerned about the price, but the speed of the execution." The broker will send the order to the exchange where your shares are traded and BUY (SELL) at the prevailing market price. Whatever the price is when the trader or computer gets there, is the price that you will get.

a)

market order

b)

stop order

c)

limit order

d)

short order

47.

Sets sell or buy limits that an investor will accept. The limit order implicitly instructs the broker to buy at a particular price. That you are "concerned about the purchase price and not the speed of the execution." A limit order may never be executed.

a)

short sales

b)

market order

c)

limit order

d)

stop order

48.

Protect a profit or stop a loss (stop loss). For example, you purchase a stock for $60 per share, you immediately set a stop loss for $57 per share. The idea being that you allow for some volatility in the stock but want to risk no more than three points. If the shares fall to $57, the computer will release the order into the trading crowd and it will be a market order.

a)

short order

b)

stop order

c)

market order

d)

limit order

49.

is act of selling borrowed securities. you contact your broker or get onto your computer a sell a security that you do not own. You borrow the security from your broker and then sell it. It is hoping that the price of the security will fall. If it does so, she or he will then buy back the security at a lower price to return them to their broker. They make money as markets are falling. You must have a margin account.

a)

market order

b)

short order

c)

short sales

d)

stop order

50.

With LONG, you buy low and sell high

a)

true

b)

false

51.

In short sales, you buy low and sell high

a)

true

b)

false

52.

when short sellers are being forced to cover their positions due to mounting losses.

a)

Short Against the Box

b)

Short Squeeze

53.

is the act of short selling a stock that you already own.

a)

Short Against the Box

b)

Short Squeeze

54.

A bond is...

a)

The left side of the bond

b)

a commitment by the issuer (the company that is borrowing the money) to pay a rate of interest for a pre-determined period of time.

c)

is the rate of interest (as an annual rate) promised by the issuing corporation for the use of your money.

55.

By selling bonds, the issuing company has raised spending power by borrowing.

a)

This is called debt financing

b)

This is called the bond's pricing

c)

This is called indenture

56.

The right side of the bond is called the bond's principal.

a)

true

b)

false

57.

The $1,000 is the bond's PAR value or the FACE amount.

a)

true

b)

false

58.

That is the rate of interest (as an annual rate) promised by the issuing corporation for the use of your money.

a)

current yield

b)

maturity date

c)

coupon yield/rate

59.

The date listed on the bond's face is

a)

interest date

b)

maturity date

c)

coupon rate

60.

The dashed lines toward the bottom of the bond's principal represent the (a) , where the terms and conditions of the bond issue are listed; it could be short or 100 pages long.

61.

The squares to the right of the principal are the bond's (a) .

62.

The bond matures naturally.

a)

Retired Serially

b)

Being Called by the issuer.

c)

Being Paid-off @ maturity.

63.

Their bonds mature at different dates rather than all at once. A portion of the issue is retired annually throughout the bond's term. Investors can pick maturity dates to meet their needs.

a)

Retired Serially

b)

Retired by Sinking Fund

c)

Being Called by the issuer.

64.

Additional protection to bond holders; it forces the issuing company to set aside funds during the bond's term. At maturity, the company has saved the money necessary to retire the principal.

a)

Retired Serially

b)

Being Called by the issuer.

c)

Retired by Sinking Fund

65.

Corporate Treasurers and CFO's are no dummies, they install Call Features into the Indenture to protect the company from interest rate risk. An example being if the company borrows money in a high interest rate environment and interest rates fall, as they have in year 2008; the company can refinance the issue as a person would refinance their house to take advantage of the lower rates.

a)

Being Called by the issuer.

b)

Being Paid-off @ maturity.

c)

Retired by Sinking Fund

66.

Being Called by the issuer has different types of calls, which are...

a)

freely callable

b)

all of them

c)

deferred call

d)

non callable

67.

the investor has NO CALL PROTECTION. The company can call the bond at any time after issue.

a)

deferred call

b)

non callable

c)

freely callable

68.

the investor has FULL PROTECTION against the call. The bond will not be retired until it matured.

a)

non calable

b)

freely callable

c)

deferred call

69.

The investor has LIMITED CALL PROTECTION. The bond may be called within the first 5 years or the last half of its life.

a)

dererred call

b)

freely callable

c)

non callable

70.

Stated on the face of the bond; is derived by dividing the ANNUAL INTEREST by the PAR value

a)

current yield

b)

coupon rate/yield

c)

yield to maturity

d)

yield to call

71.

ANNUAL INTEREST divided by (MARKET) PRICE. Once the bond is issued and is in the secondary market (has begun trading), an investor may pay a price for the bond different from par. In this case, the annual income divided by the price paid, will give the investor a more accurate yield than the coupon yield. The coupon yield will equal the current yield if the bond can be purchased at par.

a)

yield to maturity

b)

coupon rate/yield

c)

current yield

d)

yield to call

72.

The promised compounded rate of return an investor will receive from a bond purchased at the current market price and held to maturity. It captures the coupon interest to be received on the bond as well as any capital gains or losses realized by purchasing at a discount or premium. This two concepts mean the same but with just two different concepts for their formulas.

a)

current yield

b)

yield to maturity

c)

yield to call

d)

coupon rate/yield

73.

Is this formula for yield to call? YTM = {Annual Interest+[(Face Value @ Maturity-Price)/# yrs to maturity]} / [(face value @ maturity + price)/2]

a)

true

b)

false

74.

YTC = {Annual Interest+[(Call Price - Price)/# yrs to call]} / [(Call Price + Price)/2]

This formula is used for the yield to (a)

75.

is the process of calculating the intrinsic value of the bond given changes in market interest rates. This process describes interest rate risk.

a)

interest rate risk

b)

bond valuation

c)

zero coupon

76.

When interest rates increase, bond prices decrease

a)

true

b)

false

77.

Which one is the biggest riskier bond ownership?

a)

default risk

b)

Interest rate risk

c)

inflation risk

d)

liquidity risk

78.

The second biggest risk is?

a)

interest rate risk

b)

reinvestment risk

c)

maturity risk

d)

default risk

79.

(a) rate risk. Bond prices move inversely with interest rates. Other risks can be avoided or minimized, this one is more difficult to avoid. Usually bond professionals are the only ones that can sufficiently protect a portfolio against this risk.

80.

(a) risk, the risk of the issuing corporation filing for bankruptcy protection or otherwise defaulting on their obligation to pay; can come in many forms. If the company is late on a coupon payment, if they do not contribute to the sinking fund (if required), if they violate the parameters of the call features, any of these plus many more, constitute default, not just failure to pay. Investors probably perceive the failure to pay as the most serious because they are not getting paid for their investment.

81.

Since bonds are fixed income securities, this concept could consume several percentage points if not all of the bond's rate of return.

a)

Inflation risk

b)

interest rate

c)

liquidity risk

82.

If interest rates have fallen, coupons would be reinvested at a lower interest rate, thus lowering the yield to maturity. [Discussed in Yield-to-Maturity]

a)

inflation risk

b)

interest rate

c)

reinvestment risk

83.

Risk in investing in long term securities.

(a)

84.

The risk that a callable bond will be called.

a)

call risk

b)

reinvestment risk

c)

maturity risk

85.

This is coupled with quality. Thinly traded bonds may not be quickly sold.

a)

maturity risk

b)

default risk

c)

liquidity risk

86.

Bond holders have a senior position over stock holders in event the firm is liquidated or files for bankruptcy. Who gets pay first, second, and third?

a)

Common stockholders get paid first, then preferred stockholders, then bond holders.

b)

Bond holders get paid first, then preferred stockholders, then common stockholders.

87.

Debenture Bonds: Are backed only by the "full faith and credit" of the issuer. The bonds are secured debt.

a)

true

b)

false

88.

(a) 's Earn interest during the bonds life. They are sold at a "deep discount" from the face amount and mature at face. For example, a zero may be sold for $200 and mature, 20 years later at $1000. The owner gets no interest during that time

89.

The primary disadvantages of owning Zero's:

a)

Taxes are paid on earnings annually as if interest was received. The investor will be billed annually for the 'accreted' or accumulated value of the bond.

b)

Zero's can experience violent price swings more than a coupon bond due to their having no periodic coupon payments to buffer changes in market interest rates.

c)

These violent price swings could be used as a distinct advantage for the bondholder, zeros could be purchased when there is an expectation of falling interest rates.

d)

When the rates fell, zero prices would rise more than coupon bonds.

e)

All of the above

90.

There is a safer debt obligation than those issued by the US Government.

a)

true

b)

false

91.

US Treasury issues less debt than any other entity.

a)

true

b)

false

92.

Obligations are backed by the full faith and credit of the US Government. They are free of default risk, are non-callable and are tax exempt on state and local level.

a)

true

b)

false

93.

They are sold at a discount from face value and mature at face value. Federal Reserve Bank holds weekly auctions. Firms and individuals use T-Bills to park cash and defer income taxes into the next calendar year. Taxes are paid when bills mature.

a)

treasury notes

b)

treasury bonds

c)

treasury bills

94.

They pay semi-annual coupons like corporate bonds.

a)

treasury bonds

b)

treasury bills

c)

treasury notes

95.

They pay semi-annual coupons like corporate bonds. The 30-year Treasury bond is the flagship of the bond world. Many financial instruments and benchmarks are set off of the 30-year bond rate.

a)

treasury notes

b)

treasury bonds

c)

treasury bills

96.

They pay semi-annual coupons like corporate bonds. The 30-year Treasury bond is the flagship of the bond world. Many financial instruments and benchmarks are set off of the 30-year bond rate.

a)

treasury notes

b)

treasury bonds

c)

treasury bills

FIN 2302: Bond notes, security business, and time value

Total questions: 96

Worksheet time: 54mins

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