Fixed Income

Front 1

Treasury Inflation Protected Securities, which provide investors with protection against inflation by adjusting the par value and keeping the coupon rate fixed, are bestdescribed as:

A)interest-indexed bonds.

B)indexed-annuity bonds.

C)capital-indexed bonds.

Back 1

C

Indexed bonds that adjust the principal value while keeping the coupon rate fixed are best described as capital-indexed bonds. Interest-indexed bonds adjust the coupon rate. Indexed-annuity bonds are fully amortizing with the payments adjusted.

Front 2

Every six months a bond pays coupon interest equal to 3% of its par value. This bond is a:

A)3% semiannual coupon bond.

B)6% annual coupon bond.

C)6% semiannual coupon bond.

Back 2

C

The coupon rate on a bond is the percentage of its par value that it pays in interest each year. The coupon frequency states how often the bond will pay interest. A 6% semiannual coupon bond pays interest twice per year with each coupon equaling half of 6%, or 3%, of par value.

Front 3

Three bonds are identical in credit quality and all other respects except the following:

Bond X: Noncallable, accelerated sinking fund.

Bond Y: Callable, accelerated sinking fund.

Bond Z: Noncallable, no sinking fund.

The correct order for these three bonds, from highest yield to lowest yield, is:

A)Bond X; Bond Z; Bond Y.

B)Bond Y; Bond X; Bond Z.

C)Bond Y; Bond Z; Bond X.

Back 3

B

Bond Z has no provisions for early retirement (which are unfavorable for the bondholder, other things equal), so it should yield the lowest. Bond X is noncallable, but allows the issuer to redeem principal through an accelerated sinking fund. Bond Y has an accelerated sinking fund and is callable, giving the issuer the most flexibility, and therefore requiring the highest yield.

Front 4

Which of the following statements with regard to floating rate notes that have caps and floors is most accurate?

A)A cap is a disadvantage to the bondholder while a floor is a disadvantage to the issuer.

B)A floor is a disadvantage to both the issuer and the bondholder while a cap is an advantage to both the issuer and the bondholder.

C)A cap is an advantage to the bondholder while a floor is an advantage to the issuer.

Back 4

A

A cap limits the upside potential of the coupon rate paid on the floating rate bond and is therefore a disadvantage to the bondholder. A floor limits the downside potential of the coupon rate and is therefore a disadvantage to the bond issuer.

Front 5

Which of the following statements about the call feature of a bond is most accurate? An embedded call option:

A)stipulates whether and under what circumstances the issuer can redeem the bond prior to maturity.

B)stipulates whether and under what circumstances the bondholders can request an earlier repayment of the principal amount prior to maturity.

C)describes the maturity date of the bond.

Back 5

A

Call provisions give the issuer the right (but not the obligation) to retire all or a part of an issue prior to maturity. If the bonds are "called," the bondholder has no choice but to turn in his bonds. Call features give the issuer the opportunity to get rid of expensive (high coupon) bonds and replace them with lower coupon issues in the event that market interest rates decline during the life of the issue.Call provisions do not pertain to maturity. A put provision gives the bondholders certain rights regarding early payment of principal.

Front 6

A covenant that requires the issuer not to let the insurance coverage lapse on assets pledged as collateral is an example of a(n):

A)inhibiting covenant.

B)negative covenant.

C)affirmative covenant.

Back 6

C

Covenants are classified as negative or affirmative. Affirmative covenants specify administrative actions a bond issuer is required to take, such as maintaining insurance coverage on assets pledged as collateral. Negative covenants are restrictions on a bond issuer's actions, such as preventing an issuer from selling any assets that have been pledged as collateral or pledging them again as collateral for additional debt.

Front 7

A bond whose periodic payments are all equal is said to have a(n):

A)amortizing structure.

B)balloon structure.

C)bullet structure.

Back 7

A

Only a fully amortizing structure features payments that are all equal. A bullet structure pays a series of equal coupons but the final coupon is paid at the same time as the bond's principal. A final payment that includes a lump sum in addition to the last interest payment is referred to as a balloon payment.

Front 8

The indenture of a callable bond states that the bond may be called on the first business day of any month after the first call date. The call option embedded in this bond is a(n):

A)American style call option.

B)European style call option.

C)Bermuda style call option.

Back 8

C

A bond with a Bermuda style embedded call option may be called on prespecified dates after the first call date. A European style embedded call option specifies a single date on which a bond may be called. With an American style embedded call option, a bond may be called any time after its first call date.

Front 9

Allcans, an aluminum producer, needs to issue some debt to finance expansion plans, but wants to hedge its bond interest payments against fluctuations in aluminum prices. Jerrod Price, the company's investment banker, suggests a commodity index floater. This type of bond is least likely to provide which of the following advantages?

A)The bond's coupon rate is linked to the price of aluminum.

B)Allows Allcans to set coupon payments based on business results.

C)Payment structure helps protect Allcan's credit rating.

Back 9

B

The coupon rate is set in the bond agreement (indenture) and cannot be changed unilaterally. Non-interest rate indexed floaters are indexed to a commodity price such as oil or aluminum. Business results could be impacted by numerous factors other than aluminum prices.Both of the other choices are true. By linking the coupon payments directly to the price of aluminum (meaning that when aluminum prices increase, the coupon rate increases and vice versa), the non-interest index floater allows Allcans to protect its credit rating during adverse circumstances.

Front 10

The reference rate for a floating-rate note should least likely match the note's:

A)maturity.

B)reset frequency.

C)currency.

Back 10

A

An appropriate reference rate for a floating-rate note should match its currency and the frequency with which its coupon rate is reset, such as 90-day yen Libor for a yen-denominated note that resets quarterly.