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38 Cards in this Set
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In a scenario of falling interest rates and a positive yield curve, assuming all to be of equal face value, which of the following bonds will appreciate the most?
A) 20 yr bond selling at discount B) 20 yr bond selling at premium C) 1 yr bond selling at premium D) 1 yr bond selling at discount |
Answer: A
In general, prices of long term bonds are more volatile than prices of short term bonds. Therefore, 20 year bonds will appreciate more than the 1 year bonds when interest rates fall. Also, prices of bonds with low coupon rates tend to be more volatile than prices of bonds with high coupon rates. A bond sells at a discount when its coupon is lower than prevailing interest rates. Because of its lower coupon, the 20 year discount bond tends to appreciate more than the 20 year premium bond. |
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The BEST time for an investor seeking returns, to purchase long term, fixed interest rate bonds is when:
A) ST interest rates are low & beginning to rise. B) LT interest rates are low & beginning to rise. C) LT interest rates are high & beginning to decline. D) ST interest rates are high and beginning to decline. |
Answer: C
The best time to buy LT bonds is when interest rates have peaked. In addition to providing high initial return, as interest rates fall, the bonds will rise in value. |
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Market interest rates have been rising, which means that the price of bonds traded in the secondary market has:
A) not changed because only new bond prices are impacted by changes in interest rates, not the price of bonds already trading in the secondary market. B) not changed because bond prices are not affected by interest rates. C) decreased. D) increased. |
Answer: C
When interest rates rise, bond prices fall. |
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Which of the following statements regarding the economics of fixed income securities are TRUE?
1. ST interest rates are more volatile than LT rates. 2. LT interest rates are more volatile than ST rates. 3. ST bond prices react more than LT bond prices, given a change in interest rates. 4. LT bond prices react more than ST bond prices, given a change in interest rates. |
Answer: 1 & 4
There are 2 issues in this question: the volatility of rates and volatility of bond prices. ST rates are more volatile than LT rates and move more quickly than LT rates. Often the most volatile interest rate is the federal funds rate, which is an overnight rate of interest. Given a change in rates, LT bond prices move more than ST bond prices because of the compounding effect over a much longer period. |
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The result of declining inflation on outstanding bonds would be:
A) lower prices and lower yields B) higher prices and lower yields C) lower prices and higher yields D) higher prices and higher yields |
Answer: B
Declining inflation means declining interest rates. If interest rates decline, bond prices rise. |
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If an investor is anticipating that the yield spread between US Gov't and BBB rated corporate bonds will widen, the investor is expecting the US economy to:
A) enter a recession in the coming months. B) expand over the coming months. C) remain flat over the coming months. D) experience volatility over the coming months. |
Answer: A
If investors anticipate a recession, they tend to flee to quality. In this case, they would likely sell lower quality corporate bonds (forcing prices down and yields up) and use the proceeds to buy higher quality US Gov't bonds (forcing prices up and yields down). Thus, the yield spread would widen. Yields on corporate bonds are higher than yields on US Gov't bonds to begin with. If yields on corporate bonds go up and yields on US Gov't bonds decline, the spread will widen. |
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What would likely happen to the market value of existing bonds during an inflationary period coupled with rising interest rates?
A) The price of the bonds would decrease. B) The price of the bonds would increase. C) The price of the bonds would stay the same. D) The nominal yield of the bonds would increase. |
Answer: A
Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates. |
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Assume that a corp issues a 5% Aaa/AAA rated debenture at par. 2 yrs later, similarly rated debt issues are being offered in the primary market at 5.5%. Which of the following statements regarding the outstanding 5% debenture are TRUE?
1. The current yield on the debenture will be higher than 5%. 2. The current yield on the debenture will be lower than 5%. 3. The dollar price per bond will be higher than par. 4. The dollar price per bond will be lower than par. |
Answer: 1 & 4
Because interest rates have risen after the issue of the 5% debenture, the bond's price will be discounted to result in a higher current yield (Annual int. income/CMV). Accordingly, the discounting of the issue will make the 5% debenture competitive with the new issues offered with a 5.5% coupon. |
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Three 3% bonds are listed in the newspaper. One bond will mature in 1 year, another bond will mature in 10 years, and the third bond will mature in 20 years. If interest rates are going up, which bond will have the greatest decrease in value?
A) They will all have the same decrease in value. B) The bond with the 20 year maturity. C) The bond with the 1 year maturity. D) The bond with the 10 year maturity. |
Answer: B
LT bonds have the greatest interest rate risk. A bond with only 1 year to maturity will trade very close to par. |
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A 5% bond is trading at a premium. Which of the following would be the bond's highest yield?
A) Dividend yield B) Coupon yield C) Current yield D) Yield to Maturity |
Answer: B
If a bond is trading at a premium, its coupon rate will represent the highest of its yields. Bonds do not have a dividend yield.
Nominal (Coupon) Yield Current Yield YTM (Basis) YTC |
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Which of the following expressions describes the current yield of a bond?
A) Annual interest payment / par value B) Annual interest payment / CMV C) YTM / par value D) YTM / CMV |
Answer: B
The current yield on a bond = Annual interest / CMV |
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Currently, a co. issues a 5% Aaa/AAA debentures at par. 2 yrs ago, the corp issued 4% AAA debentures at par. Which of the following statements regarding the outstanding 4% issue are true?
1. The dollar price per bond will be higher than par. 2. The dollar price per bond will be lower than par. 3. The CY on the issue will be higher than the coupon. 4. The CY on the issue will be lower than the coupon. |
Answer: 2 & 3
Interest rates in general have risen since the issuance of the 4% bonds, so the bond's price will be discounted to produce a higher CY on the bonds. Remember that as interest rates go up, the price of the outstanding debt securities goes down. |
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A bond purchased at $900 with a 5% coupon and a 5 year maturity has a current yield of:
A) 5.6% B) 5% C) 7.4% D) 7.8% |
Answer: A
CY = annual interest / CMV $50 / $900 = 5.6% Years to maturity is not a factor in calculating CY. |
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A customer purchases a 4% corporate bond yielding 5%. A year before the bond matures, new corp bonds are issued at 3% and the customer sells the 4% bond. Which of the following statements regarding the bond are TRUE?
1. The customer bought it at a discount. 2. The customer bought it at a premium. 3. The customer sold it at a premium. 4. The customer sold it at a discount. |
Answer: 1 & 3
A 4% bond yielding 5% has a YTM of 5%. If a bond's YTM is higher than its coupon (or nominal yield), the bond is selling at a discount to par. If interest rates decline, new bonds will be issued with lower coupons, and outstanding bonds with higher coupons will trade at a premium.
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Yields from highest to lowest for bonds trading at a PREMIUM:
Nominal Yield (Coupon) Current Yield YTM (Basis) YTC |
Yields from highest to lowest when bonds are trading at a DISCOUNT:
YTC YTM (Basis) Current Yield Nominal Yield (Coupon) |
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A bond offered at par has a coupon rate:
A) less than its YTM B) greater than its YTM C) equal to its CY D) less than its CY |
Answer: C
When selling at par, all of the yields are the same. |
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Two par bonds are issued with coupons of 5.2% & 5.4%, respectively. The 20 basis point difference is:
A) $2 B) $10 C) $20 D) $100 |
Answer: C
One basis point = .01% Difference between 5.2% & 5.4% is .20% = 20 basis points. Bond 1 pays $52 interest Bond 2 pays $54 interest Difference of $2 |
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An inverted yield curve is the result of:
A) investors buying LT bonds & selling ST bonds B) investors buying ST bonds & selling LT bonds C) investors moving from equities to debt instruments D) investors moving from debt instruments to equity instruments |
Answer: A
When investors believe interest rates may decline soon, they seek to lock in the current rate of return by buying LT bonds. Increased demand increases price & causes the yields on LT debt instruments to fall. In addition, selling ST bonds depresses prices, causing yields to rise. As a result, the yield curve takes on a negative slope. ST yields are then higher than LT yields, which is the definition of an inverted curve. |
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If all of the following bonds mature on Sept. 1, 2020, which would have the highest price?
A) 5 1/2% coupon at 5.50 B) 5 3/4% coupon at 5.85 C) 6 3/4% coupon at 6.80 D) 6 1/4% coupon at 6.10 |
Answer: D
A bond that is trading at a premium has a YTM that is lower than its coupon rate. Of the choices given, only the 6 1/2% coupon with a 6.10 YTM is trading at a premium. The other bonds shown are either trading at a discount (their YTM is higher than the coupon rate) or at par (their YTM is = coupon rate). |
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An investor purchases a corporate bond at par to yield 5.5% to maturity (YTM). If he sells the bond at a price equivalent to a 5% YTM 2 years later, the investor incurs:
A) no taxable result at this time B) tax-free income C) a capital loss D) a capital gain |
Answer: D
Yields fall as bond prices rise. The bond price dropped from 5.5% to 5%, which results in the bond trading at a premium, which would then result in a capital gain. |
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In which of the following will a change in interest rates cause the greatest price fluctuation?
A) 7% AA rated 1 yr municipal note B) 7% AAA rated corporate bond with 8 years til maturity C) Series EE bond D) 7% 30 yr US Treasury bond |
Answer: D
Price fluctuations affect bonds most with the longest terms to maturity. The more risky the instrument, the more price volatility. LT bonds have greater risk than ST bonds. |
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A corporate bond with a nominal yield (coupon) of 6% is currently trading at a YTM of 5.8%. It would be accurate to state that this bond is trading at:
A) a discount B) par C) parity D) a premium |
Answer: D
A bond is trading at a premium if other yields are less than the nominal yield (coupon).
Nominal Yield (Coupon) Current Yield YTM (Basis) YTC |
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An 8% corporate bond is offered on a 8.25 basis (YTM). Which of the following statements are TRUE?
1. NY is higher than YTM 2. CY is higher than NY (coupon) 3. NY is lower than YTM 4. CY is lower than NY |
Answer: 2 & 3
Yields for bonds trading at a DISCOUNT in order from lowest to highest:
NY (coupon) CY YTM (basis) YTC |
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The current yield on a bond with a coupon rate of 7.5% currently selling at 105 1/2 is approximately:
A) 8% B) 7.1% C) 6.5% D) 7.5% |
Answer: B
Coupon rate of 7.5% = $75 annual interest CY = annual interest / CMV or $75 / $1055 = 7.109% |
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Which of the following statements regarding a $1000 corporate 8.5% bond offered at 110 is TRUE?
A) To determine the bond's CY, its stated rate must be compared against other fixed rate investments in the client's portfolio. B) The bond is a discount bond. C) The bond's CY is calculated by dividing its annual interest by its CMV D) The bond's CY is lower than its YTM |
Answer: C
CY = annual interest / CMV The bond is trading at a premium, so yields from highest to lowest are:
NY (coupon) Current Yield YTM (basis) YTC |
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Which of the statements below BEST describe why a normal yield curve is positively sloped?
A) Investors demand higher interest when lending their money for longer periods. B) Investors logically demand higher returns from Gov't securities than they do from corporate securities. C) ST bonds generally fluctuate in price more than LT bonds. D) Stocks generally have lower yields than bonds, although their total returns may be higher. |
Answer: A
When the yield curve is positively sloped (and thus normal), LT bonds carry higher interest rates than ST bonds of the same quality. |
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If the yield curve is currently inverted:
A) it signifies a time of easy credit. B) LT rates are higher than ST C) LT & ST rates move inversely. D) LT rates are lower than ST rates. |
Answer: D
A normal yield curve reflects ST rates below LT rates. An inverted or negative yield curve reflects the opposite. This usually occurs during a period of tight money. |
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A customer buys an 8% bond on an 8.20 basis. If the bond is callable in 5 years at par and matures in 10 years, which of the following statements is TRUE?
A) Nominal yield is higher than YTM B) Nominal yield is higher than YTC C) YTC is higher than YTM D) YTC is lower than YTM |
Answer: C
DISCOUNT = lowest to highest: NY (coupon) = 8% CY YTM (basis) = 8.20 YTC |
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A 10 yr. bond, callable in 5 years at par, is sold at a discount. Rank the following yields from lowest to highest:
1. Nominal yield (coupon) 2. Current yield 3. Yield to Call 4. Yield to Maturity (basis) |
Answer: 1, 2, 4, 3
DISCOUNT / Ranked lowest to highest:
NY (coupon) CY YTM (basis) YTC |
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An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing:
A) ST bonds when int. rates are high B) ST bonds when int. rates are low C) LT bonds when int. rates are high D) LT bonds when int. rates are low |
Answer: C
If an investor purchases bonds when int. rates are high, a drop in int. rates will lead to a corresponding increase in bond value. LT debt instruments will fluctuate to a greater degree than those with ST int. rates. Thus, LT debt offers the greater chance at gain. |
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6% XYZ debentures are trading for $1200. Other similarly rated bonds are being offered at 4.5%. What is the CY on the 6% debentures?
A) 6% B) 7.5% C) 5% D) 1.5% |
Answer: C
CY = annual interest income / CMV
$60 / $1200 = 5% |
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A bond has a 7% coupon and an offering price of 102. Which of the following yields could be the YTM for this bond?
A) 0.0702 B) 0.0707 C) 0.0709 D) 0.0655 |
Answer: D
For a bond trading at a premium, the ranking of yields from highest to lowest:
NY (coupon) CY YTM (basis) YTC |
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All of the following bonds have 5 yrs to go to maturity. Which would have the greatest price change in response to a change in interest rates?
A) 7 1/2%, A rated, price 102 B) 7 1/2%, B rated, price 88 C) 7 1/2%, BBB rated, price 95 D) 7 1/2%, AA rated, price 108 |
Answer: B
Factors increasing a bond's response to an interest rate change include:
Time left to maturity Distance from par Lower rating
Bonds with the lowest ratings & farthest from par would have the greatest price change. |
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If general int. rates increase, the int. income of an open-end bond fund will:
A) remain unchanged B) It cannot be determined from this info C) increase D) decrease |
Answer: C
Most mutual funds do not have 100% of their assets in securities & they continually receive new money from investors. Any increase in the general int. rate would allow the fund to purchase new, higher-yielding, lower cost instruments, which would increase the fund's income. |
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If a fund has a fixed portfolio of municipal bonds with long maturities, how will substantial changes in general interest rates affect the fund's portfolio?
A) The current value will not change, but the investment income will fluctuate significantly. B) Both the income & the current value will fluctuate significantly. C) Both the income & the current value will remain unchanged. D) The current value will fluctuate significantly, but the investment income will remain relatively unchanged. |
Answer: D
For a fund with a fixed portfolio of LT muni bonds, the market value of the portfolio will fluctuate with changing int. rates, but the income will remain unchanged. |
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Which of the following appreciates MOST during a period of falling interest rates?
A) 7.4% coupon, 3 1/3 year maturity B) 7.6% coupon, 3 1/2 year maturity C) 7% coupon, 2 7/8 year maturity D) 7.2% coupon, 3 year maturity |
Answer: B
Although the bonds would appreciate in value as a result of failing interest rates, bonds with longer maturities experience a greater appreciation than do shorter maturities. While lower coupon bonds tend to be more price sensitive, the over-riding factor will first be length of time to maturity. |
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Which of the following investments is the LEAST appropriate for a qualified pension or profit sharing plan?
A) Corporate AAA Bonds B) Zero coupon Bonds C) Municipal Bonds D) Treasury Bonds |
Answer: C
When advising qualified plans, it is not a good investment practice to buy tax-free income. The yield on muni bonds is typically lower than that on other bonds of comparable quality due to the tax-exempt status of their income pmts. Any assets in the retirement plan are already free of current taxation so the muni security benefit is lost and the portfolio contains assets that produce less income. A 2nd prob arises b/c as assets are withdrawn, the w/d is usu 100% taxable, thus turning what is inherently tax free into something taxable. Therefore, it makes more sense to buy higher yielding taxable income and to shelter the income within the tax-exempt plan. |
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If the yield curve is currently inverted:
A) it signifies a time of easy credit B) LT rates are lower than ST rates C) LT rates are higher than ST rates D) LT & ST rates move inversely |
Answer: B
A normal yield curve reflects the ST rates below LT rates. An inverted or negative yield curve reflects the opposite. This usually occurs during a period of tight money. |
