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Debt Quiz

Terms in this set (49)

Moody's Investment Grade (MIG) rating is used for:\

A. Municipal long term bonds
B. Municipal short term notes
C. Corporate long term bonds
D. Corporate short term notes
The best answer is B.

"MIG" stands for Moody's Investment Grade and is the rating used for short term municipal notes. Short term corporate obligations are rated "P" (Prime). Both long term corporate and municipal offerings are rated on an "ABC" scale.
A 6% corporate bond with 15 years left to maturity is currently trading at 115. The bond is callable in 5 years at 105. If a client buys the bond and then the issuer calls it in 5 years, the yield to call will be:

A. 2.68%
B. 3.64%
C. 4.54%
D. 6.00%
The best answer is B.

YTC is Net Annual Return / Average Value. The annual income is 6% of $1,000 par = $60 per year. The bond can be purchased at 115, but it will be called in 5 years at 105, so there will be a 10 point ($100) loss over 5 years = 2 point loss ($20) per year.

The Net Annual Return is: Annual Income ($60) - Annual Loss ($20) = $40

The Average Value is: $1,150 Purchase Price + $1,050 Redemption Price / 2 = $2,200 / 2 = $1,100

YTC is: $40 / $1,100 = 3.636%
During periods when the yield curve is inverted, which statements are TRUE?

I Debt defaults are probably at historically high levels
II Issuers are likely to sell non-callable bonds
III Debt investors expect that interest rates will fall in the future
IV Debt investors expect that economic activity will decline

A. II, III, IV
B. I, II, III
C. I, III, IV
D. I, II, III, IV
The best answer is C.

When the yield curve is inverted, short term rates are higher than long term rates. This typically occurs when the Federal Reserve pursues a "tight money" policy to slow the economy. The tightening of credit raises interest rates overall, slows economic activity, and thus business defaults increase. Long term rates remain lower than short term rates since investors do not expect the tightening to last far into the future. During periods when the yield curve is inverted, interest rates on all maturities tend to shift upwards, with short term rates rising the most. During these periods of high interest rates, issuers are likely to sell callable issues (not non-callable ones). If interest rates decrease in the future (as expected), the issuer can call in the old debt and refinance at lower current interest rates.
Which of the following do NOT have an equity position?

A. Convertible preferred shareholders
B. Preferred shareholders
C. Convertible debenture holders
D. Common shareholders
The best answer is C.

Bondholders do not have an equity position - they are creditors of the corporation.

Note: A debenture is a type of bond.

Common and preferred shareholders have an equity position.
When bonds are trading at a large discount, which of the following statements are TRUE?

I The deeper the discount, the more volatile the bond's price movement in response to interest rate changes
II The deeper the discount, the less volatile the bond's price movement in response to interest rate changes
III Discount bonds with long maturities are more volatile than ones with short maturities
IV Discount bonds with short maturities are more volatile than ones with long maturities

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.

As a general rule, the deeper the discount, the more volatile the bond's price movements in response to market interest rate changes. The deepest discount bond that can be purchased is a "zero coupon" bond. Such a bond has the most volatile price movements. Also, the longer the maturity, the more volatile the bond's price movements in response to market interest rate changes.
The nominal yield of a bond will:

A. increase as bond prices fall
B. remain unchanged as bond prices fluctuate
C. increase as bond prices rise
D. decrease as bond prices rise
The best answer is B.

The nominal yield is the stated rate of interest as a percentage of par value. It does not change as bond prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.
In 2021, a customer buys 5 GE 10% debentures, M '29, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2025 at 103. The nominal yield on the bonds is:

A. 10.00%
B. 10.81%
C. 11.76%
D. 12.43%
The best answer is A.

The nominal yield is the stated rate of interest on the bond, based on par value.

$100/$1,000= 10%
A declining rate of inflation would lead to:

I lower bond prices
II higher bond prices
III lower bond yields
IV higher bond yields

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.

A declining rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise.
Which of the following are required to calculate the yield to maturity of a bond?

I Maturity Date
II Coupon
III Purchase Price
IV Redemption Price (Par)

A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is D.

The coupon rate x par value gives the annual interest. The annual capital gain or loss is the difference between the purchase price and the redemption price divided by the number of years to maturity. Therefore, all of the items listed are required to calculate the YTM of a bond.
Which of the following would be a quote for a U.S. Government bond?

A. 105.625
B. 105-20
C. 105 5/8
D. 105 10/16
The best answer is B.

U.S. Government bonds are quoted on a percentage of par basis in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond.

Choice C is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond.

Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
All of the following would be purchasers of Eurodollar bonds EXCEPT:

A. British investors
B. French investors
C. Japanese investors
D. United States investors
The best answer is D.

Since Eurodollar bonds are not registered with the SEC, and they are not exempt from these registration requirements, they cannot be offered within the United States.
Which of the following securities is NOT eligible for Fed trading?

A. Treasury Bonds
B. Treasury Bills
C. Commercial Paper
D. Prime Banker's Acceptances
The best answer is C.

Commercial paper, which is issued by corporations, is not eligible for Fed trading. The eligible securities are U.S. Government debt, Government Agency debt, and prime Banker's Acceptances. These are the securities that the Fed trades with the primary U.S. Government dealers (the major commercial banks and brokerage firms) to control credit availability in the economy.
If the Federal Reserve enters into reverse repurchase agreements with member banks, the:

I Federal Reserve is tightening credit availability
II Federal Reserve is loosening credit availability
III Federal Funds rate is likely to go down
IV Federal Funds rate is likely to go up

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.

The Federal Funds rate is the interest rate charged between Federal Reserve member banks on overnight loans. The Federal Reserve can influence this rate through open market operations. If the Fed enters into reverse repurchase agreements with member banks, it drains the member banks of reserves, tending to drive up the Fed Funds rate (there would be less cash available for the member banks to lend). Conversely, if the Fed enters into repurchase agreements with member banks, it injects cash into the banks, which tends to drive the Fed Funds rate down (since there is more cash available for member banks to lend).
A Prime Banker's Acceptance is one:

A. rated AAA by Moody's
B. rated P-1 by Moody's
C. eligible for trading with the Federal Reserve
D. eligible for trading with commercial banks
The best answer is C.

A Prime BA is of sufficient quality to be an eligible for Fed trading.
Which of the following statements are TRUE regarding overnight repurchase agreements?

I The seller loses control of the underlying securities for the duration of the agreement
II The interest rate charged is most similar to the Federal Funds rate
III The investment has interest rate risk
IV The investment has no liquidity risk

A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is D.

All of the statements are true regarding repurchase agreements. Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will "sell" some of its inventory overnight to another dealer, with an agreement to buy the position back the next day. The difference between the sale price and the repurchase price is the interest earned. There is virtually no liquidity risk, since the loan is of the shortest term and is secured by pledged government securities. The interest rate on such agreements generally parallels and is somewhat lower (since the loans are secured) than the Fed funds rate, since overnight loans using government securities are most similar to overnight loans of reserves (Fed Funds) from bank to bank. Since government securities are pledged as collateral, the dealer gives up custody of the securities overnight. Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth!
An ETN does NOT have which risk?

A. Market risk
B. Credit risk
C. Marketability risk
D. Reinvestment risk
The best answer is D.

An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. Thus, if the bank's credit rating is lowered, the value of the ETN will fall as well - so it has credit risk. ETNs are listed on an exchange and trade, so they have minimal marketability risk. ETNs have market risk - if market prices fall, their value will fall in the market. Finally, ETNs make no interest or dividend payments - so they do not have reinvestment risk. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates.

ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. These products typically have a 7 year maturity and a lot can go wrong in 7 years.
If the issuing bank is downgraded, then it would be expected that investor interest in the ETN would fall. This should make the issue less marketable and also should cause the price to fall.
Auction Rate Securities:
I have the interest rate reset weekly via Dutch auction
II have a fixed interest rate for the life of the issue set by competitive bid auction
III have an embedded put option
IV do not have an embedded put option

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.

Auction Rate Securities are long-term debt issues where the interest rate is reset weekly (or monthly) via Dutch auction. This gives the issuer the advantage of paying a short-term market interest rate on a long-term security. However, unlike a variable rate demand note (VRDO), they have no embedded put option - meaning that the issuer is not obligated to buy them back at the reset date. The failure of the weekly auctions in 2008 created a situation where holders could not sell these securities to get out of them.
To smooth out cash flow, a corporation will issue:

A. TANs
B. RANs
C. BANs
D. Commercial paper
The best answer is D.

Commercial paper is a short term unsecured IOU issued by corporations. TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes) are municipal short term notes.
The principal difference between a structured product and an ETN is:

A. investment time horizon
B. liquidity risk
C. credit risk
D. reference index
The best answer is B.

Regarding structured products, each bank's version has different features. They are "buy and hold" securities - there is almost no trading market. ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated.
The interest rate paid on Eurodollar deposits is:

A. Prime rate
B. LIBOR
C. Fed Funds Rate
D. Discount rate
The best answer is B.

Eurodollar deposits are U.S. currency held in banks in foreign countries, mainly in Europe. The Eurodollar market is centered in London - and the interest rate paid on these deposits is "LIBOR" = London Interbank Offered Rate.
A selling dealer offering municipal bonds "firm for 1/2 hour with a 5 minute recall" means all of the following EXCEPT:

A. prices for bonds that are offered can't be changed for a stated period
B. the selling dealer has specified that he can recontact the buying dealer to reinstate a different price within a certain time period
C. the buying dealer can try and "round up" a customer for the bonds before the dealer actually purchases the bonds
D. the selling dealer has the right to rescind the price at any time
The best answer is D.

The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period that buying dealer can try and round up a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.
Municipal bonds would not be an appropriate investment for which of the following?

A. Individual Retirement Accounts
B. Individuals
C. Casualty Companies
D. Bank Holding Companies
The best answer is A.

It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments, into the account. Tax is due only when the positions are liquidated and the funds withdrawn from the account. Individuals in high tax brackets buy municipal bonds for their federal income tax exemption; insurance companies buy municipal issues as part of their portfolios; and banks buy municipals as part of their investment portfolio (for example, they purchase "bank qualified" municipal issues that give the bank a large tax advantage).
A "calamity call" is a(n):

A. mandatory call
B. extraordinary mandatory call
C. optional call
D. extraordinary optional call
The best answer is B.

A calamity call obligates an issuer to call in the bonds, returning the borrowed monies to the bondholders, if a catastrophic event occurs that destroys a facility that is the revenue source backing the issue. This is an "extraordinary event" and it is mandatory that the bonds be called.
As stated in the flow of funds found in a revenue bond issue's trust indenture, before the revenues collected are applied to the operations and maintenance fund, revenues are placed in the:

A. Revenue Fund
B. Debt Service Reserve Fund
C. Sinking Fund
D. Reserve Maintenance Fund
The best answer is A.

The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are first deposited to a revenue fund. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.
A municipal issuer sells $5,000,000 of a $10,000,000 bank qualified issue to a bank trust department. Which statement is true?

A. The bank cannot deduct any of the related interest carrying charges on the funds used to purchase the bonds
B. The bank can deduct 20% of the related interest carrying charges on the funds used to purchase the bonds
C. The bank can deduct 80% of the related interest carrying charges on the funds used to purchase the bonds
D. The bank can deduct 100% of the related interest carrying charges on the funds used to purchase the bonds
The best answer is C.

A "bank qualified" municipal issue is an issue of $10,000,000 or less that has been designated by the issuer as a "bank qualified issue." To be bank qualified, it must be a public purpose (not private purpose issue). Any bank that buys the issue receives a tax benefit that is not available on all other municipal investments. The bank can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank. This is sometimes termed the 80/20 rule. If an issue is not bank qualified, then none of the interest expense that the bank incurs on deposits used to fund the purchase of the bonds can be deducted. This is logical since the interest income from the bonds is exempt from Federal taxation.
The income source backing a special tax bond issue could be:

I Cigarette taxes
II Sales taxes
III Ad valorem taxes
IV Business taxes

A. I only
B. II only
C. I, II, IV
D. I, II, III, IV
The best answer is C.

Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales, business or income taxes).
The ratio of pledged revenues to debt service requirements is:

A. Pledged revenues / annual interest expense
B. Pledged revenues / annual interest expense and mandatory sinking fund deposits
C. Annual interest expense / pledged revenues
D. Annual interest expense and mandatory sinking fund deposits / pledged revenues
The best answer is B.

The ratio of pledged revenues to debt service requirements is:

The ratio should be comfortably above 1, meaning that the issuer can easily pay annual debt service requirements from pledged revenues.
An "unqualified" legal opinion is one which:

A. gives a conditional affirmation of the legality of the securities
B. gives an unconditional affirmation of the legality of the securities
C. is given by an unqualified bond counsel
D. disqualifies the issue from legal issuance
The best answer is B.

An unqualified legal opinion is a "clean" opinion, where the bond counsel has found no legal problems. Thus, the opinion is an unconditional affirmation of the legality of the issue.
What source of information provides dealer offerings of municipal bonds in the secondary market?

A. Munifacts
B. EMMA
C. Bloomberg
D. The Bond Buyer
The best answer is C.

Bloomberg gives dealer offerings of municipal bonds in the secondary market. It simply shows the amount offered, name of the municipal issuer and bond type, coupon rate, basis or price, and the name of the firm offering the security.

EMMA is the MSRB's municipal bond website, intended for retail investors (EMMA stands for Electronic Municipal Market Access). It reports completed trades of municipal bonds (but does not show dealer quotes) and also includes the Official Statement for each municipal issue outstanding. The Official Statement (OS) is the disclosure document, similar to a prospectus.

The Bond Buyer is the "new issue" municipal newspaper. Municipal issuers place announcements of new issues in this publication. Munifacts is a newswire service of the Bond Buyer that mainly announces new issue offerings by syndicates, and also includes some general news items that can affect the secondary market.
To ease temporary cash flow shortages, municipalities will issue which of the following?

I General obligation bonds
II Tax anticipation notes
III Revenue anticipation notes
IV Moral obligation bonds

A. I and IV only
B. II and III only
C. I, II, III
D. I, II, III, IV
The best answer is B.

To ease a temporary cash flow shortage, municipalities will issue either TANs (Tax Anticipation Notes) or RANs (Revenue Anticipation Notes). These notes are paid off when the taxes or anticipated revenues are collected sometime in the near future. Long term bond issues (like General obligation bonds and moral obligation bonds) are not appropriate to meet cash flow shortages.
Treasury Bills:

I mature in 1 year or less
II mature in over 1 year
III are issued by the United States Government
IV are issued by United States Government Agencies

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.

Treasury bills mature in 52 weeks or less and are issued by the U.S. Government.
A government securities dealer quotes a 3 month Treasury Bill at 6.00 Bid - 5.90 Ask. A customer who wishes to buy 1 Treasury Bill will pay:

A. a dollar price quoted to a 5.90 basis
B. a dollar price quoted to a 6.00 basis
C. $5,900
D. $6,000
The best answer is A.

Treasury Bills are quoted on a yield basis. From the basis quote, the dollar price is computed. A customer who wishes to buy will pay the "Ask" of 5.90. This means that the dollar price will be computed by deducting a discount of 5.90 percent from the par value of $100. This is the discount earned over the life of the instrument.
Which statements are TRUE regarding Treasury STRIPS?

I Interest is accreted annually
II Interest is not accreted annually
III Interest is subject to Federal income tax annually
IV Interest is not subject to Federal income tax annually

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.

The accretion of the discount over the bond's life represents the interest earned. Even though no payments of interest are made annually, the discount must be accreted annually and is taxable as interest income earned.
All of the following statements are true about PAC tranches EXCEPT:

A. If prepayment rates slow down, the PAC tranche will receive its sinking fund payment prior to its companion tranches
B. If prepayment rates rise, the PAC tranche will receive its sinking fund payment after its companion tranches
C. PAC tranche holders have lower prepayment risk than companion tranche holders
D. PAC tranche holders have higher extension risk than companion tranche holders
The best answer is D.

Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments that are made earlier than the PAC maturity are made to the Companion classes before being applied to the PAC (this would occur if interest rates drop); while principal repayments made later than anticipated are applied to the PAC maturity before payments are made to the Companion class (this would occur if interest rates rise). Thus, the PAC class is given a more certain maturity date and hence lower prepayment risk; while the Companion classes have a higher level of prepayment risk if interest rates drop; and they have a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.
Collateralized mortgage obligations may be backed by all of the following securities EXCEPT:

A. Real Estate Investment Trusts
B. Freddie Mac Pass Through Certificates
C. FNMA Pass Through Certificates
D. GNMA Pass Through Certificates
The best answer is A.

CMO tranches are generally AAA rated (or have an implied AAA rating because the tranches are backed by GNMA, FNMA or Freddie Mac pass-through certificates). REITs are common stock companies that make direct investments in real estate.
Which statement is TRUE regarding fully modified pass-through certificates issued by the Government National Mortgage Association?

A. Monthly payments of interest and principal are guaranteed by the U.S. Government
B. Only interest payments are guaranteed by the U.S. Government
C. Only principal payments are guaranteed by the U.S. Government
D. The yield at which the investor bought the certificate is guaranteed by the U.S. Government
The best answer is A.

The "modification" to a fully modified Ginnie Mae Pass Through Certificate is the guarantee of the U.S. Government on the timely payment of both interest and principal.
A customer buys 5M of 3 1/2% Treasury Bonds at 101-16. How much will the customer receive at each interest payment?

A. $17.50
B. $35.00
C. $87.50
D. $175.00
The best answer is C.

"5M" means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 3.5% of $5,000 face amount equals $175.00. Since interest is paid semi-annually, each payment will be for $87.50.

Notice that the fact that the bond is trading at a premium is irrelevant - the interest payment is based on the stated interest rate times par value.
Which of the following statements are TRUE about the Government National Mortgage Association (GNMA)?

I GNMA is a publicly traded corporation
II GNMA is owned by the U.S. Government
III GNMA pass through certificates are guaranteed by the U.S. Government
IV GNMA pass through certificates are not guaranteed by the U.S. Government

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.

GNMA performs the same function as Fannie Mae except that its pass through certificates are guaranteed by the U.S. Government; and it remains an agency of the government. It has not been "sold off" as a private company, like Fannie Mae, which, since it is bankrupt and is in government conservatorship, now trades OTC. For as long as the government continues to guarantee Ginnie Mae securities, it cannot be a publicly traded company.
Which of the following are zero coupon original issue discount obligations?
I Treasury Bills
II Treasury Notes
III Treasury Bonds
IV Treasury STRIPS

A. I and IV only
B. II and III only
C. II, III, IV
D. I, II, III, IV
The best answer is A.

Treasury Bills and STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. Treasury Notes and Bonds are issued at par with a stated interest rate.
Treasury Receipts pay interest:

A. quarterly
B. semi annually
C. annually
D. at maturity
The best answer is D.

Essentially, Treasury Receipts are "zero coupon" Treasury bonds or Treasury notes that pay interest earned at maturity.

Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.
All of the following statements are true regarding a bond that is "registered to principal only" EXCEPT:

A. the bond is negotiable
B. interest coupons are detached from the corpus of the bond
C. interest payments can be redeemed by anyone
D. at maturity, the registered owner receives the face amount of the bond
The best answer is B.

A registered to principal only bond has a physical certificate with the bond's face amount registered in the owner's name, but interest coupons are attached which are payable to the "bearer." Bearer coupons can be redeemed by anyone. The bonds are negotiable. No new issues have been sold in the U.S. since 1983 - after this point only fully registered or book entry bonds have been issued. However, these bonds still trade in the market (at least until 2023, if the bond had 40 years to maturity).
Which statements are TRUE about adjustment (income) bonds?

I Any interest payment made is predictable in amount
II Any interest payment made is not predictable in amount
III Timing of interest payments made is predictable
IV Timing of interest payments made is not predictable

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.

Income bonds only pay interest if the corporation earns enough "income" to make that interest payment. So, timing of payments is not predictable. However, if a payment is made, the amount received is the stated rate of interest on the bond - so the payment amount (if the payment is made) is predictable.
Which of the following statements are TRUE regarding corporate obligations?

I Corporate bonds are traded on the NYSE
II Corporate bonds are not traded on the NYSE
III Corporate bonds are traded over-the-counter
IV Corporate bonds are not traded over-the-counter

A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.

Though a very small amount of corporate bonds are traded on the NYSE (in a separate trade matching computer), most of the trading volume takes place over-the-counter between corporate bond dealers such as Goldman Sachs and other firms.
A corporation has issued 10%, $1,000 par convertible debentures, convertible at $31.25. The common stock is currently trading at $35. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay:

A. $3,500
B. $4,800
C. $5,000
D. $5,600
The best answer is D.

The bonds are convertible at $31.25, based on $1,000 par value. Therefore each bond converts into 32 shares ($1,000 par / $31.25 conversion price). If the common is trading at $35, the bond must be trading at 32 times this to be at parity. $35 x 32 = $1,120 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $1,120 x 5 = $5,600.
In a period of steep increases in interest rates, which issuer is most likely to be negatively affected?

A. Trucking company
B. Utility company
C. Mining company
D. Technology company
The best answer is B.

Utilities are capital intensive - building electric generating plants is expensive! To obtain long term funds, utilities can issue either stock or bonds. Because their revenue stream is stable, utilities can issue large amounts of bonds at favorable interest rates without negatively affecting their credit rating.

The vast majority of utility financing is done via the issuance of mortgage bonds. It is typical for a utility to have 90% of its capitalization come from the sale of bonds with only 10% from equity. It contrast, mature manufacturing companies can rarely have more than 30% of their capital base coming from the issuance of debt without negatively affecting their credit rating.

If interest rates rise steeply, as its bonds mature, the utility must replace them with new bonds at steeply higher interest rates. This increases its interest cost (which is one of its largest expenses), so earnings will deteriorate, and the price of the stock will fall in the market. Because the other industries listed cannot issue such a large amount of bonds, the negative impact of higher current market rates is not as great.
The Standard and Poor's Bond Guide includes information on:

A. Corporate Bonds
B. U.S. Government Bonds
C. Municipal Bonds
D. Agency Bonds
The best answer is A.

Standard and Poor's Bond Guide is published on the web, and gives capsule summaries of every outstanding corporate issue, including recent price, rating, and yield.
A convertible bond is convertible into common stock at a 32:1 ratio. The common stock is currently trading at $30. The bond is currently trading at $980. What is the conversion price?

A. $30.00
B. $30.63
C. $31.25
D. $32.67
The best answer is C.

The conversion price is found by taking $1,000 par and dividing this by the conversion ratio. $1,000 / 32 = $31.25 conversion price.
A customer buys 10M of Allied Corporation 12% debentures, M '29, at 90 on Tuesday, Oct 9th. The interest payment dates are Feb. 1st and Aug 1st. The trade settled on Thursday, October 11th. The amount of the next interest payment will be:

A. $300
B. $600
C. $900
D. $1,200
The best answer is B.

10M stands for 10 - $1,000 bonds (M is Latin for $1,000) = $10,000 face amount of bonds. The bonds pay 12% interest annually. 12% of $10,000 is $1,200. However, the question asks how much will be received in the next payment. Since bonds pay interest semi-annually, the amount received per payment is $600.
Which of the following debt securities may be issued by a corporation?

I Mortgage bonds
II Equipment trust certificates
III Moral obligation bonds
IV Adjustment bonds

A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.

Corporations do not issue moral obligation bonds. Municipalities that are at their legal debt limits may issue such bonds, which morally obligate them to pay (but there is no legal obligation to pay). Corporations can issue mortgage bonds backed by real property. Corporations can issue equipment trust certificates backed by equipment owned by the company. Finally, corporations can issue adjustment bonds, also known as income bonds, that obligate the issuer to pay only if there are sufficient earnings (these are also known as "income" bonds).
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