Series 7 Cram Cards, Kier Passperfect - Chapter 2

Front 1

The interest received from a Collateralized Mortgage Obligation is subject to:

A Federal income tax only

B State income tax only

C Local income tax only

D Federal, State and Local income tax

Back 1

D Federal, State and Local income tax

Front 2

A customer has an objective of maximizing current income. Under which conditions would you recommend that the customer sell long term debt positions and buy short term obligations?

A The yield curve is normal

B The yield curve is inverted

C The yield curve is hump shaped

D The yield curve is ascending

Back 2

B The yield curve is inverted

Front 3

Which of the following are direct obligations of the U.S. Government?

A Treasury Receipts

B Ginnie Maes

C Government Bond Mutual Funds

D Fannie Maes

Back 3

A Treasury Receipts

Front 4

When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)?

A Both interest and principal payments are made semi-annually

B Interest is paid semi-annually and principal is paid at maturity

C Principal is paid semi-annually and interest is paid at maturity

D Both interest and principal are paid at maturity

Back 4

D Both interest and principal are paid at maturity

Front 5

The city of Jacksonville, Florida is issuing $100,000,000 of general obligation bonds paying interest on January 1st and July 1st of each year until maturity. The dated date of the issue is June 1, 2016. The first payment will be made on January 1st, 2017. A bondholder purchases the issue at the offering. The first interest payment is a(n):

A level first interest payment

B even first interest payment

C odd first interest payment

D odd-lot first interest payment

Back 5

C odd first interest payment

Front 6

Which of the following provide fundamental analytical information about municipal issues?

I Fitch's

II Standard and Poor's

III Best's

IV Moody's

Back 6

C I, II, IV

Front 7

Which of the following would be a quote for a U.S. Government bond?

A 99.50

B 99-16

C 99 1/2

D 99 8/16

Back 7

A 99.50

Front 8

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), which statements are TRUE?

I PACs are similar to TACs in that both provide call protection against increasing prepayment speeds

II PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds

III PAC holders have a degree of protection against extension risk that is not provided to TAC holders

IV TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates

Back 8

D I, II, III, IV

Front 9

All of the following would be included in the Net Bonded Debt of a municipal issuer EXCEPT:

A Non-self supporting general obligation bonds

B Partially self supporting general obligation bonds

C Non-self supporting revenue bonds

D Self supporting revenue bonds

Back 9

C Non-self supporting revenue bonds

Front 10

Municipal term bonds are generally quoted on a:

A yield to call basis

B yield to maturity basis

C current yield basis

D dollar price basis

Back 10

D dollar price basis

Front 11

Bond Basics: Purchasing Power Risk

Back 11

If inflation rates increase, interest rates increase as well.

If interest rates increase, bond prices fall - this is purchasing power risk.

Front 12

Bond Basics: Marketability Risk

Back 12

Marketability risk is the risk that a security will be difficult to sell.

Smaller, thinly traded issues are most subject to marketability risk.

Front 13

Bond Basics: Liquidity Risk

Back 13

Liquidity risk is the risk that selling a position will result in higher than normal transaction costs (commissions). This is typical for smaller, thinly traded issues.

Short term maturity issues are easier to trade than longer term maturities and have less liquidity risk (and also less marketability risk).

Front 14

Bond Basics: Reinvestment Risk

Back 14

Reinvestment risk is the risk that interest rates drop after the issuance of a bond, and the semi-annual interest payments received from a bond are now reinvested at lower current market rates. Thus, the overall rate of return on the investment is reduced.

Zero-coupon bonds do not make periodic interest payments, and hence, do not have reinvestment risk.

Front 15

Bond Basics: Exchange Rate Risk

Back 15

When an investment is made outside the U.S. that is denominated in a foreign currency, the investor assumes exchange rate risk.

This is the risk that the foreign currency weakens against the U.S. dollar (which is the same as the U.S. dollar strengthening).

When the "weakened" foreign currency is converted back into its value in U.S. dollars, it buys "fewer" U.S. dollars, so the value of the investment in terms of U.S. dollars, declines.

Front 16

Bond Basics: Yield Curve Analysis

Back 16

The yield curve shows the yields of bonds of the same type and credit rating, with differing maturities.

Front 17

There are 3 theories as to the "shape" of the curve:

Back 17

Liquidity preference theory

Market expectations theory

Market segmentation theory

Front 18

Liquidity preference theory:

Back 18

Investors prefer liquidity, and so demand a higher yield for less liquid longer maturities; and will accept a lower yield for more liquid short maturities.

Front 19

Market expectations theory:

Back 19

The "shape" of the curve shows the direction in which interest rates will head in the future. If the curve slopes upwards, then interest rates are expected to rise; if it is sloping downwards, then interest rates are expected to fall; if it is flat, then interest rates are expected to remain unchanged.

Front 20

Market segmentation theory:

Back 20

The shape of the curve depends on the balance of supply and demand at each major "segment" of the curve.

Front 21

Bond Basics: Normal Yield Curve

Back 21

A normal yield curve is one where short term rates are lower than long term rates. This is the typical yield curve shape, during periods of economic expansion.

Also note that short term interest rates are more volatile than long term interest rates, because they are the rates that are subject to Federal Reserve actions. Do not confuse interest rate volatility with bond price volatility - short term interest rates are more volatile while for a given change in interest rates, long term bond prices are more volatile.

Front 22

Bond Basics: Inverted Yield Curve

Back 22

An inverted yield curve is one where short term rates are higher than long term rates.

This is the typical yield curve shape during periods when the Federal Reserve is tightening short term credit to slow down the economy.

Front 23

Bond Basics: Flat Yield Curve

Back 23

A flat yield curve is one where short term rates are the same as long term rates.

This is the typical curve shape when the economy is transitioning between economic growth and recession.

Front 24

Bond Basics: Yield Spread

Back 24

The yield spread compares the yield curve for AAA rated corporate bonds to U.S. Government bonds.

Interest rates are higher for top rated corporate bonds than for U.S. Government bonds, due to greater credit risk; and the fact that corporate bonds are subject to State and Local income tax while U.S. Governments are exempt.

Example: The yield on 30-year U.S. Government bonds might be 4%, while at the same time the yield on top rated 30 year corporate bonds is 7% - the yield spread is 3%.

If the economy heads into recession, people sell corporate bonds (lowering prices and raising yields); and buy U.S. Government bonds for safety (raising prices and lowering yields). Thus, corporate yields might move up to 8% and U.S. Government yields might move down to 3% - the yield spread has widened to 5%.

If the economy expands, people sell U.S. Government bonds (lowering prices and raising yields); and buy corporate bonds for extra yield (raising prices and lowering yields). Thus, U.S. Government yields might move up to 5% and corporate yields might move down to 6% - the yield spread has narrowed to 1%.

Thus, in times of economic recession, the yield spread widens; in times of economic expansion, the yield spread narrows.

Front 25

Bond Basics: Yield Curve Summary

No matter what the shape of the yield curve, the following statements are true:

Back 25

Long term bond prices are more volatile than short term bond prices in response to market interest rate changes.

Short term interest rates are more volatile than long term interest rates.

Front 26

When bonds issued at par trade at a discount, this is caused by:

Back 26

Market interest rates rising; or

A deterioration of the issuer's credit rating.

Bonds trading at a discount have more volatile price movements than premium bonds.

Bonds trading at a discount are unlikely to be called.

Front 27

When bonds issued at par trade at a premium, this is caused by:

Back 27

Market interest rates falling; or

An improvement in the issuer's credit rating.

Bonds trading at a premium have less volatile price movements than discount bonds.

Bonds trading at a premium are likely to be called.

Front 28

When a bond is called, it is to the benefit of the __________ and the detriment of the ___________.

Back 28

Issuer; bondholder

Front 29

Characteristics of Corporate Debt

Back 29

All new issues come out in "book entry" form. No physical certificates are issued. The paying agent keeps the record of the registered owner and sends the semi-annual interest payments and the final principal repayment directly to the registered owner. Book entry bonds are much cheaper to produce than printed bond certificates.

Front 30

"Older" bonds were issued as physical certificates and these still trade in the market until they mature. These bonds come in the following forms:

Back 30

Bearer Form

Registered to Principal Only Form

Registered to Principal and Interest Form

Front 31

Bearer Form:

Back 31

The bond certificate is payable to the "bearer" at maturity and the bond has rows of semi-annual bearer coupons attached for each interest payment date. Anyone can clip a coupon and present it for payment at its due date and anyone can present the certificate for redemption at maturity. These were last issued in 1983, so 40-year issues still trade until 2023.

Front 32

Registered to Principal Only Form:

Back 32

The bond certificate is payable to the name of the registered owner at maturity and the bond has rows of semi-annual bearer coupons attached for each interest payment date. Anyone can clip a coupon and present it for payment at its due date but only the registered owner can present the certificate for redemption at maturity. These were last issued in 1983, so 40-year issues still trade until 2023.

Front 33

Registered to Principal and Interest Form:

Back 33

The bond certificate is payable to the name of the registered owner at maturity and there are no coupons attached to the bond. The paying agent mails the semi-annual interest payments to the registered owner and the registered owner can redeem the bond at maturity. These were last issued in the mid-1990s.

Front 34

Corporate Debt: Funded Debt

Back 34

Funded debt is long term corporate debt, typically with at least a 5 year life.

The term "funded" debt arises from the fact that this debt is a source of long term funds for the issuer; contrast an "unfunded" debt which is a short term debt that must be repaid shortly.

Also note that this term is generally no longer used, but it is tested.

Front 35

Corporate Debt: Trust Indenture

Back 35

The trust indenture appoints a trustee to oversee the adherence of the issuer to all of the promises made by the issuer to the bondholders in the bond contract.

The trust indenture is a contract between the issuer and the trustee (where the trustee is acting for the benefit of the bondholders).

All corporate bonds are required to have a trust indenture to protect the bondholders.