Fixed income Question bank 2018 CFA level1

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Fixed-Income Securities: Defining Elements and Issuance, Trading,

has been upgraded

is indexed for inflation

Explanation

Inflation-indexed bonds often have a capital-indexed structure in which the principal value is adjusted periodically by the inflation

rate Credit rating upgrades or downgrades do not affect the principal value of bonds A bond is trading at a premium when its

market price is greater than its principal value

Which of the following least likely represents a primary market offering? When bonds are sold:

in a private placement.

from a dealer's inventory

on a best-efforts basis

Explanation

When bonds are sold from a dealer's inventory, the bonds have already been sold once and the transaction takes place on the

secondary market The other transactions in the responses take place in the primary market When bonds are sold on a

best-efforts basis, the investment banker does not take ownership of the securities and agrees to sell all she can In a private

placement, the bonds are sold privately to a small number of investors

A bond is quoted at 96.25 bid and 96.75 ask Based only on this information, this bond is most likely:

a corporate bond.

non-investment grade

relatively illiquid

Explanation

The spread between the bid and ask prices is one-half percent of par, which most likely reflects an illiquid market for this bond

Bonds with liquid secondary markets typically have bid-ask spreads of approximately 10 to 12 basis points

Question #4 of 67 Question ID: 415452

To reduce the cost of long-term borrowing, a corporation with a below average credit rating could:

issue securitized bonds.

issue commercial paper

decrease credit enhancement

Explanation

Commercial paper is only issued by corporations with top credit ratings Decreasing credit enhancements increase the cost of borrowing

An analyst observes a 5-year, 10% coupon bond with semiannual payments The face value is £1,000 How much is each

The coupon rate is the percentage of par value paid annually With semiannual coupons, half of the annual coupon rate is paid

every six months For a 5-year, 10% coupon bond with semiannual payments and a face value of £1,000, each coupon payment

Excess spread is an example of internal, not external credit enhancement

As compared to an equivalent noncallable bond, a callable bond's yield should be:

the same.

lower

higher

Explanation

Question #8 of 67 Question ID: 415462

A floating-rate note has a coupon rate based on a market-determined reference rate such as 90-day LIBOR Typically the coupon

rate will be stated as a margin above the reference rate A variable-rate note has a margin above the reference rate that is not

fixed over the life of the note An index-linked bond has a coupon payment or principal amount that adjusts based on the value of

a published index such as an equity market, commodity, or inflation index

Which of the following statements about U.S Treasury Inflation Protection Securities (TIPS) is most accurate?

Adjustments to principal values are made annually.

The inflation-adjusted principal value cannot be less than par

The coupon rate is fixed for the life of the issue

Explanation

The coupon rate is set at a fixed rate determined via auction This is called the real rate The principal that serves as the basis of

the coupon payment and the maturity value is adjusted semiannually Because of the possibility of deflation, the adjusted

principal value may be less than par (however, at maturity the Treasury redeems the bonds at the greater of the inflation-adjusted

principal and the initial par value)

A purchase of a new bond issue by a single investor is most accurately described as a(n):

Question #11 of 67 Question ID: 415482

If two banks fund a loan to a corporation, the loan is most accurately described as a:

bilateral loan.

backup line of credit

syndicated loan

Explanation

Syndicated loans are funded by more than one bank A bilateral loan involves only one bank ("bilateral" refers to the lender and

the borrower) A backup line of credit is an agreement to provide funds if needed and may be used, for example, to provide credit

enhancement for a commercial paper issue

A bond initially does not make periodic payments but instead accrues them over a pre-determined period and then pays a lump

sum at the end of that period The bond subsequently makes regular periodic payments until maturity Such a bond is best

Deferred-coupon bonds carry coupons, but the initial coupon payments are deferred for some period The coupon payments

accrue, at a compound rate, over the deferral period and are paid as a lump sum at the end of that period After the initial

deferment period has passed, these bonds pay regular coupon interest for the rest of the life of the issue (i.e., until the maturity

date) Zero coupon bonds do not pay periodic interest A step-up note has a coupon rate that increases on one or more specified

dates during the note's life

Which of the following is least likely a form of internal credit enhancement for a bond issue?

Covering the bond issue via a surety bond.

Structuring the asset pool such that it has an excess spread

Including a tranche system to identify priority of claims

Explanation

A surety bond is issued by a third party and hence is an external form of credit enhancement

Treasury Inflation Protected Securities, which provide investors with protection against inflation by adjusting the par value and

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

An investor holds $100,000 (par value) worth of TIPS currently trading at par The coupon rate of 4% is paid semiannually, and

the annual inflation rate is 2.5% What coupon payment will the investor receive at the end of the first six months?

$2,000.

$2,025

$2,050

Explanation

This coupon payment is computed as follows:

Which of the following issues is most accurately described as a eurobond?

South Korean firm's euro-denominated bonds sold to investors in the European Union.

Brazilian firm's U.S dollar-denominated bonds sold to investors in Canada

European Union firm's Japanese yen-denominated bonds sold to investors in Japan

Explanation

Eurobonds are denominated in a currency other than that of the countries in which they are issued The name "eurobond" does

not imply that a bond is sold in Europe or by a European issuer, or denominated in the euro currency A U.S dollar-denominated

bond sold to investors outside the United States is called a "eurodollar bond."

Which of the following statements about zero-coupon bonds is least accurate?

A zero coupon bond may sell at a premium to par when interest rates decline.

The lower the price, the greater the return for a given maturity

All interest is earned at maturity

Question #18 of 67 Question ID: 415469

Zero coupon bonds always sell below their par value, or at a discount prior to maturity The amount of the discount may change

as interest rates change, but a zero coupon bond will always be priced less than par

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):

European style call option.

Bermuda style call option

American style call option

Explanation

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

PRC International just completed a $234 million floating rate convertible bond offering As stated in the indenture, the interest

rate on the bond is the lesser of 90-day LIBOR or 10% The indenture also requires PRC to retire $5.6 million per year with the

option to retire as much as $10 million Which of the following embedded options is most likely to benefit the investor? The:

accelerated sinking fund provision for principal repayment.

conversion option on the convertible bonds

10% cap on the floating interest rate

Explanation

The conversion privilege is an option granted to the bondholder The cap benefits the issuer The accelerated sinking fund might

reduce the investor's default risk, but the conversion option is the most likely benefit to the investor

Settlement for a government bond trade most often occurs on the:

same day as the trade.

third trading day after the trade

next trading day after the trade

Explanation

Government bond trades typically settle on the next trading day (T + 1) Money market instruments typically have cash

settlement (settle on the same day) Settlement for corporate bond trades is typically on the third trading day after the trade (T +

3)

Question #21 of 67 Question ID: 415456

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?

Allows Allcans to set coupon payments based on business results.

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

Payment structure helps protect Allcan's credit rating

Explanation

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

Which of the following embedded bond options tends to benefit the borrower?

Interest rate cap.

Conversion option

Put option

Explanation

The interest rate cap benefits the borrower who issues a floating rate bond The cap places a restriction on how high the coupon

rate can become during a rising interest rate environment Therefore, the floating rate borrower is protected against ever-rising

interest rates

The interbank funds market is most accurately described as:

trading of negotiable certificates of deposit.

banks' borrowing of reserves from the central bank

unsecured short-term loans from one bank to another

Explanation

The interbank funds market refers to short-term unsecured loans between banks It does not refer to trading of negotiable

certificates of deposit Borrowing from the central bank is said to occur in the central bank funds market

Question #24 of 67 Question ID: 415457

Consider a floating rate issue that has a coupon rate that is reset on January 1 of each year The coupon rate is defined as

one-year London Interbank Offered Rate (LIBOR) + 125 basis points and the coupons are paid semi-annually If the one-year

LIBOR is 6.5% on January 1, which of the following is the semi-annual coupon payment received by the holder of the issue in

This value is computed as follows:

Semi-annual coupon = (LIBOR + 125 basis points) / 2 = 3.875%

A bond has a par value of $5,000 and a coupon rate of 8.5% payable semi-annually The bond is currently trading at 112.16

What is the dollar amount of the semi-annual coupon payment?

Which of the following statements about floating-rate notes is most accurate?

Floating-rate notes have built-in floors, while inverse floating-rate notes have built-in caps.

The coupon payment on a floating-rate note at each reset date is typically based on LIBOR as of that

date

Inverse floating-rate notes are attractive to investors who expect interest rates to rise, while

floating-rate notes are attractive to investors who expect interest rates to fall

Explanation

The lowest possible reference rate is zero If this occurs, the coupon on a floating-rate note cannot go lower than its quoted

margin Hence, the quoted margin is a floor coupon for a floating-rate note The coupon on an inverse floater is determined by a

formula such as "15% - 1.5 × reference rate." If the reference rate goes to zero, the coupon on this inverse floater can go no

higher than 15%

Question #27 of 67 Question ID: 415446

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

Which of the following fixed income securities is classified as a money market security?

Security issued 18 months ago that will mature in six months.

Newly issued security that will mature in one year

Security issued six months ago that will mature in one year

Explanation

Money market securities have original maturities of one year or less Fixed income securities originally issued with maturities

longer than one year are classified as capital market securities

Compared to a term repurchase agreement, an overnight repurchase agreement is most likely to have a:

lower repo rate and higher repo margin.

higher repo rate and repo margin

lower repo rate and repo margin

Explanation

Both the repo rate and the repo margin tend to be higher for longer repo terms Therefore an overnight repo should have a lower

repo rate and a lower repo margin than a term (i.e., longer than overnight) repo

A repurchase agreement is described as a "reverse repo" if:

a bond dealer is the lender.

the repurchase price is lower than the sale price

Bond dealers frequently use repurchase agreements as sources of funding When a bond dealer enters a repo as the lender

instead of the borrower, the agreement is referred to as a reverse repo

A structured security is a combination of:

a corporate bond and a syndicated loan.

a medium-term note and a derivative

commercial paper and a backup line of credit

Explanation

Medium-term notes (MTNs) that are combined with derivatives to create features desired by an investor are known as structured

securities

Which of the following statements regarding repurchase agreements is most accurate?

Lower credit rating of the underlying collateral results in a lower repo margin.

Greater demand for the underlying security results in a lower repo margin

Higher credit rating of the underlying collateral results in a higher repo rate

Explanation

Other things equal, the repo margin (percent difference between the market value of the collateral and the loan amount) is lower

if the collateral is in greater demand The repo margin and repo rate (the annualized percent difference between the sale price

and repurchase price of the collateral) are inversely related to the credit quality of the collateral

On November 15, 20X1, Grinell Construction Company decided to issue bonds to help finance the acquisition of new

construction equipment They issued bonds totaling $10,000,000 with a 6% coupon rate due June 15, 20X9 Grinell has agreed

to pay the entire amount borrowed in one lump sum payment at the maturity date Grinell is not required to make any principal

payments prior to maturity What type of bond structure has Grinell issued?

Serial maturity structure.

Term maturity structure

Amortizing maturity structure

Explanation

These bonds have a term maturity structure because the issuer has agreed to pay the entire amount borrowed in one lump-sum

Question #34 of 67 Question ID: 415461

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

Which type of issuer is most likely to issue bonds by auction?

Sovereign.

Corporate

Municipal

Explanation

Many national governments use auctions to issue sovereign bonds Corporate bonds are typically issued in an underwriting or

private placement process while municipal bonds are typically issued in a negotiated or underwritten process

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:

Bond Y; Bond Z; Bond X.

Bond Y; Bond X; Bond Z

Bond X; Bond Z; Bond Y

Explanation

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

Question #37 of 67 Question ID: 415443

A bond's indenture least likely specifies the:

covenants that apply to the issuer.

identity of the lender

source of funds for repayment

Explanation

The identity of the lender (i.e., the bondholder) is not specified in a bond's indenture because a bond may be traded during its

life An indenture or trust deed is a legal contract that specifies a bond issuer's obligations and restrictions The indenture may

include covenants that require the issuer to take or refrain from taking certain actions and may specify the source of funds for

repayment, such as a project to be funded or the taxing power of a government

The most appropriate reference rate for a one-year, U.S dollar denominated, floating-rate note that resets monthly is:

1-year LIBOR.

30-day LIBOR

overnight LIBOR

Explanation

The reference rate for floating-rate debt should match the frequency with which the coupon rate is reset

Securitized bonds are most likely to be issued by:

special purpose entities.

banking institutions

supranational entities

Explanation

The issuer of a securitized bond is typically a special purpose entity (SPE), also known as a special purpose vehicle (SPV) or

special purpose company (SPC) An SPE is formed specifically to purchase and administer assets that will provide the cash

flows to pay interest and principal on bonds the entity issues These bonds are called securitized bonds

Features specified in a bond indenture least likely include the bond's:

issuer and rating.

par value and currency.

coupon rate and maturity date

Explanation

Bond ratings are assigned by third-party credit rating agencies and may change during the life of a bond Features that are

specified in the indenture for a fixed income security include its issuer, maturity date, par value, coupon rate and frequency, and

Sources of short-term funding for banks that are generally not available to other corporations include retail customer deposits,

certificates of deposit, central bank funds, and interbank lending Syndicated loans and commercial paper issuance are funding

sources available to other corporations as well as banks

Which of the following statements regarding a sinking fund provision is most accurate?

It permits the issuer to retire more than the stipulated amount if they choose.

It requires that the issuer retire a portion of the principal through a series of principal payments over

the life of the bond

It requires that the issuer set aside money based on a predefined schedule to accumulate the cash

to retire the bonds at maturity

Explanation

A sinking fund actually retires the bonds based on a schedule This can be accomplished through either payment of cash or

through the delivery of securities An accelerated sinking fund provision allows the company to retire more than is stipulated in

the indenture, but not all sinking fund provisions allow this

Which of the following entities play a critical role in the ability to create a securitized bond with a higher credit rating than the corporation?

Special purpose vehicles.

Rating agencies

Investment banks

Question #44 of 67 Question ID: 434400

SPVs, or special purpose entities (SPEs), buy the assets from the corporation The SPV separates the assets used as collateral from the

corporation that is seeking financing This shields the assets from other creditors

Which of the following statements regarding Eurobonds is least accurate? Eurobonds are:

issued simultaneously to investors in many countries.

issued in a currency other than the issuer's domestic currency

typically registered rather than bearer bonds

Explanation

Eurobonds are typically bearer bonds rather than registered because they are issued outside the jurisdiction of any single

country

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

describes the maturity date of the bond.

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

stipulates whether and under what circumstances the bondholders can request an earlier repayment

of the principal amount prior to maturity

Explanation

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

Negative covenants are restrictions on a borrower's actions Affirmative covenants are actions a borrower is required to take

There is no category known as neutral covenants

Question #47 of 67 Question ID: 415455

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

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.

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

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

Explanation

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

Which of the following bond covenants is considered negative?

Payment of taxes.

Maintenance of collateral

No additional debt

Explanation

Negative covenants set forth limitations and restrictions, whereas affirmative covenants primarily set forth administrative activities

that the borrower promises to do

Fixed income classifications by credit quality most likely include:

money market securities.

developed market bonds

investment grade bonds

Explanation

Investment grade and non-investment grade are classifications by credit quality Money market instruments are a classification by

maturity Developed market bonds are a classification by geography

In most countries including the United States, debenture is defined as:

a short-term debt instrument.

a bond secured by specific assets

In most countries a debenture is defined as unsecured debt.

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

6% semiannual coupon bond.

3% semiannual coupon bond

6% annual coupon bond

Explanation

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

A bond is trading at a premium if its:

yield is greater than its coupon rate.

redemption value is greater than its face value

price is greater than its par value

Explanation

If a bond's price is greater than its par value, the bond is trading at a premium If a bond's yield is greater than its coupon rate, its

price is less than par value and the bond is trading at a discount Face value and redemption value both refer to par value

Settlement for corporate bond trades generally happen on what basis?

Cash settlement.

Trade date + 1 day

Trade date + 3 days

Explanation

Corporate bonds typically settle on the third trading day after the trade (T + 3) Some money market securities are settled on the

trade date (cash settlement) and government bonds typically settle on the trading day following the trade date (T + 1)

Fixed income classifications by geography most likely include:

supranational bonds.

emerging market bonds

municipal bonds

Explanation

Classifying fixed income securities as developed market or emerging market bonds is an example of classification by geography

Supranational bonds are a classification by type of issuer Municipal bonds are a classification by type of issuer or by taxable

Covenants are provisions of a bond indenture Credit ratings are assigned by independent rating agencies The underwriter, if

any, of a bond issue is not identified in the indenture but would be identified in the offering documents

Bonds issued by the International Monetary Fund (IMF) are most accurately described as:

quasi-government bonds.

supranational bonds

non-sovereign government bonds

Explanation

Supranational bonds are issued by multilateral organizations such as the IMF Quasi-government bonds are issued by agencies

created by a national government Non-sovereign government bonds are issued by state, provincial, and local governments or

municipal entities

Fixed income classifications by issuer most likely include:

Financial sector bonds.

Money market securities

Explanation

Corporate bonds are frequently classified by issuer as financial or non-financial Floating-rate bonds are a classification by

coupon structure Money market securities are a classification by original maturities

Which of the following embedded options in a fixed income security can be exercised by the issuer?

Put option.

Conversion option

Call option

Explanation

Securities with embedded call options may be called by the issuer An embedded put option gives the bondholder the right to sell

(put) the security back to the issuer A conversion option gives the bondholder the right to exchange the security for the issuer's

common stock

Which of the following is a general problem associated with external credit enhancements? External credit enhancements:

are very long-term agreements and are therefore relatively expensive.

are subject to the credit risk of the third-party guarantor

are only available on a short-term basis

Explanation

If the guarantor is downgraded, the issue itself could be subject to downgrade even if the structure is performing as expected

Which of the following securities is least likely classified as a eurobond? A bond that is denominated in:

euros and issued in the United States.

U.S dollars and issued in Japan

euros and issued in Germany

Explanation

Bonds denominated in the currency of the country or region where they are issued are domestic bonds Eurobonds are

denominated in a currency other than those of the countries in which they are sold

Question #61 of 67 Question ID: 415463

Consider $1,000,000 par value, 10-year, 6.5% coupon bonds issued on January 1, 20X5 The market rate for similar bonds is

currently 5.7% A sinking fund provision requires the company to redeem $100,000 of the principal each year Bonds called under

the terms of the sinking fund provision will be redeemed at par A bondholder would:

prefer to have her bonds called under the sinking fund provision.

be indifferent between having her bonds called under the sinking fund provision or not called

prefer not to have her bonds called under the sinking fund provision

Explanation

With the market rate currently below the coupon rate, the bonds will be trading at a premium to par value Thus, a bondholder

would prefer not to have her bonds called under the sinking fund provision

Which of the following is least likely an example of external credit enhancement?

A putable bond favors the buyer (investor) Hence, a premium will be paid for the option, which means the yield will be lower

Which of the following contains the overall rights of the bondholders?

Covenant.

Indenture

Rights offering

Question #65 of 67 Question ID: 415473

An indenture specifies the rights of bondholders and the obligations of the issuer Covenants are specific provisions within the

indenture A rights offering is typically associated with an equity security

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

maturity.

currency

reset frequency

Explanation

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

Which of the following is a difference between an on-the-run and an off-the-run issue? An on-the-run issue:

is publicly traded whereas an off-the-run issue is not.

tends to sell at a lower price

is the most recently issued security of that type

Explanation

An on-the-run issue is the most recently auctioned Treasury issue An off-the-run issue older issues, when more current issues

are brought to market

A company desiring to issue a fixed-income security has placed $10 million worth of loan receivables in a special purpose vehicle

(SPV) that is independent of the issuer The credit rating agencies suggest the company secure a third-party guarantee in order

to have the security rated AAA After completing the transfer of assets to the SPV and obtaining a letter of credit from a national

bank, the company issues the AAA rated security The securities are most likely:

Introduction to Fixed-Income Valuation - 1 Test ID: 7711858

An interpolated spread (I-spread) for a bond is a yield spread relative to:

benchmark spot rates.

swap rates

risk-free bond yields

Explanation

Spreads relative to swap rates are referred to as Interpolated or I-spreads

Consider a 10-year, 6% coupon, $1,000 par value bond, paying annual coupons, with a 10% yield to maturity The change in the

bond price resulting from a 400 basis point increase in yield is closest to:

Therefore, the price is expected to change from $754.22 to $582.71, a decrease of $171.51

Other things equal, for option-free bonds:

the value of a long-term bond is more sensitive to interest rate changes than the value of a

short-term bond.

a bond's value is more sensitive to yield increases than to yield decreases

the value of a low-coupon bond is less sensitive to interest rate changes than the value of a

high-coupon bond

Explanation

Long-term, low-coupon bonds are more sensitive than short-term and high-coupon bonds Prices are more sensitive to rate

decreases than to rate increases (duration rises as yields fall)

Question #4 of 70 Question ID: 472422

A fixed coupon callable bond issued by Protohype Inc is trading with a yield to maturity of 6.4% Compared to this YTM, the

bond's option-adjusted yield will be:

lower.

the same

higher

Explanation

The option-adjusted yield is the yield a bond with an embedded option would have if it were option-free For a callable bond, the

option-adjusted yield is lower than the YTM This is because the call option may be exercised by the issuer, rather than the

bondholder Bond investors require a higher yield to invest in a callable bond than they would require on an otherwise identical

option-free bond

A $1,000 par, semiannual-pay bond is trading for 89.14, has a coupon rate of 8.75%, and accrued interest of $43.72 The flat

price of the bond is:

$847.69.

$935.12

$891.40

Explanation

The flat price of the bond is the quoted price, 89.14% of par value, which is $891.40

Austin Traynor is considering buying a $1,000 face value, semi-annual coupon bond with a quoted price of 104.75 and accrued

interest since the last coupon of $33.50 Ignoring transaction costs, how much will the seller receive at the settlement date?

$1,047.50.

$1,014.00

$1,081.00

Explanation

The full price is equal to the flat or clean price plus interest accrued from the last coupon date Here, the flat price is 1,000 ×

104.75%, or 1,000 × 1.0475 = 1,047.50 Thus, the full price = 1,047.50 + 33.50 = 1,081.00

Tony Ly is a Treasury Manager with Deeter Holdings, a large consumer products holding company The Assistant Treasurer has

Callable at $1,060 in two years

If Ly calculates correctly, the current yield and yield to call are approximately:

To calculate the CY and YTC, we first need to calculate the present value of the bond: FV = 1,000, N = 14 = 7 × 2, PMT = 35

=(1000 × 0.07)/2, I/Y = 4.5 (9 / 2), Compute PV = -897.77 (negative sign because we entered the FV and payment as positive

numbers)

Then, CY = (Face value × Coupon) / PV of bond = (1,000 × 0.07) / 897.77 = 7.80%.

And finally, YTC calculation: FV = 1,060 (price at first call), N = 4 (2 × 2), PMT = 35 (same as above), PV = -897.77 (negative

sign because we entered the FV and payment as positive numbers), ComputeI/Y = 7.91 (semi-annual rate, need to multiply by 2)

= 15.82%.

A zero-coupon bond has a yield to maturity of 9.6% (annual basis) and a par value of $1,000 If the bond matures in 10 years,

today's price of the bond would be:

Question #10 of 70 Question ID: 415602

The forward rate is computed as follows:

One-year forward rate = 1.065 / 1.05 - 1 = 8.02%

Assume a bond's quoted price is 105.22 and the accrued interest is $3.54 The bond has a par value of $100 What is the bond's clean

The clean price is the bond price without the accrued interest so it is equal to the quoted price

A 20-year, 9% semi-annual coupon bond selling for $914.20 offers a yield to maturity of:

A 5-year bond with a 10% coupon has a present yield to maturity of 8% If interest rates remain constant one year from now, the

price of the bond will be:

the same.

higher

lower

Explanation

A premium bond sells at more than face value, thus as time passes the bond value will converge upon the face value

Bond X is a noncallable corporate bond maturing in ten years Bond Y is also a corporate bond maturing in ten years, but Bond Y

is callable at any time beginning three years from now Both bonds carry a credit rating of AA Based on this information:

The zero-volatility spread of Bond X will be greater than its option-adjusted spread.

Bond Y will have a higher zero-volatility spread than Bond X

The option adjusted spread of Bond Y will be greater than its zero-volatility spread

Explanation

Bond Y will have the higher Z-spread due to the call option embedded in the bond This option benefits the issuer, and investors

will demand a higher yield to compensate for this feature The option-adjusted spread removes the value of the option from the

spread calculation, and would always be less than the Z-spread for a callable bond Since Bond X is noncallable, the Z-spread

and the OAS will be the same

What value would an investor place on a 20-year, $1,000 face value, 10% annual coupon bond, if the investor required a 9% rate

of return?

Harmon Moving has a 13.25% coupon semiannual coupon bond currently trading in the market at $1,229.50 The bond has eight

years remaining until maturity, but only two years until first call on the issue at 107.50% of $1,000 par value Which of the

following is closest to the yield to first call on the bond?

Which of the following describes the yield to worst? The:

yield given default on the bond.

lowest of all possible yields to call

lowest of all possible prices on the bond

Explanation

Yield to worst involves the calculation of yield to call for every possible call date, and determining which of these results in the lowest

expected return

Given the one-year spot rate S = 0.06 and the implied 1-year forward rates one, two, and three years from now of: 1 1 = 0.062; 2 1 =

0.063; 3 1 = 0.065, what is the theoretical 4-year spot rate?

Question #20 of 70 Question ID: 415499

A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10% What is the

value of the bond today if the coupon rate is 12%?

A semiannual-pay bond is callable in five years at $1,080 The bond has an 8% coupon and 15 years to maturity If an investor

pays $895 for the bond today, the yield to call is closest to:

Yield curves are typically constructed for bonds of the same or similar issuers, such as a government bond yield curve or AA

rated corporate bond yield curve

4

Question #23 of 70 Question ID: 415563

An 11% coupon bond with annual payments and 10 years to maturity is callable in 3 years at a call price of $1,100 If the bond is

selling today for 975, the yield to call is:

A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10% What is the

value of the bond today if the coupon rate is 8%?

McClintock 8% coupon bonds maturing in 10 years are currently trading at 97.55 These bonds are option-free and pay coupons

semiannually The McClintock bonds have a:

true yield greater than the street convention.

yield to maturity greater than 8.0%

current yield less than 8.0%

Explanation

A bond trading at a discount will have a YTM greater than its coupon The current yield is 8 / 97.55 = 8.2% True yield is adjusted

for payments delayed by weekends and holidays and is equal to or slightly less than the yield on a street convention basis

Current spot rates are as follows:

1-Year: 6.5%

2-Year: 7.0%

3-Year: 9.2%

Which of the following statements is most accurate

For a 3-year annual pay coupon bond, the first coupon can be discounted at 6.5%, the second

coupon can be discounted at 7.0%, and the third coupon plus maturity value can be

discounted at 9.2% to find the bond's arbitrage-free value.

For a 3-year annual pay coupon bond, all cash flows can be discounted at 9.2% to find the bond's

arbitrage-free value

The yield to maturity for 3-year annual pay coupon bond can be found by taking the geometric

average of the 3 spot rates

Explanation

Spot interest rates can be used to price coupon bonds by taking each individual cash flow and discounting it at the appropriate

spot rate for that year's payment Note that the yield to maturity is the bond's internal rate of return that equates all cash flows to

the bond's price Current spot rates have nothing to do with the bond's yield to maturity

Ron Logan, CFA, is a bond manager He purchased $50 million in 6.0% coupon Southwest Manufacturing bonds at par three

years ago Today, the bonds are priced to yield 6.85% The bonds mature in nine years The Southwest bonds are trading at a:

discount, and the yield to maturity has increased since purchase.

discount, and the yield to maturity has decreased since purchase

premium, and the yield to maturity has decreased since purchase

Explanation

The yield on the bonds has increased, indicating that the value of the bonds has fallen below par The bonds are therefore

trading at a discount If a bond is selling at a discount, the bond's current price is lower than its par value and the bond's YTM is

higher than the coupon rate Since Logan bought the bonds at par (coupon = YTM = 6%), the YTM has increased

Question #29 of 70 Question ID: 415515

Consider a 6-year $1,000 par bond priced at $1,011 The coupon rate is 7.5% paid semiannually Six-year bonds with comparable credit

quality have a yield to maturity (YTM) of 6% Should an investor purchase this bond?

Yes, the bond is undervalued by $38.

No, the bond is overvalued by $64

Yes, the bond is undervalued by $64

Today an investor purchases a $1,000 face value, 10%, 20-year, semi-annual bond at a discount for $900 He wants to sell the

bond in 6 years when he estimates the yields will be 9% What is the estimate of the future price?

Note: Calculate the PV (we are interested in the PV 6 years from now), not the FV

A coupon bond pays annual interest, has a par value of $1,000, matures in 4 years, has a coupon rate of $100, and a yield to

maturity of 12% The current yield on this bond is:

Question #32 of 70 Question ID: 415593

The current yield on a bond is equal to:

annual interest divided by the current market price.

the yield to maturity

the internal rate of return

Explanation

The formula for current yield is the annual cash coupon payment divided by the bond price

Assume that a callable bond's call period starts two years from now with a call price of $102.50 Also assume that the bond pays

an annual coupon of 6% and the term structure is flat at 5.5% Which of the following is the price of the bond assuming that it is

called on the first call date?

In the context of bonds, accrued interest:

covers the part of the next coupon payment not earned by seller.

is discounted along with other cash flows to arrive at the dirty, or full price

2

This is a correct definition of accrued interest on bonds.

The other choices are false Accrued interest is not discounted when calculating the price of the bond The statement, "covers the

part of the next coupon payment not earned by seller," should read, " not earned by buyer."

A 10-year spot rate is least likely the:

yield-to-maturity on a 10-year coupon bond.

yield-to-maturity on a 10-year zero-coupon bond

appropriate discount rate on the year 10 cash flow for a 20-year bond

Explanation

A 10-year spot rate is the yield-to-maturity on a 10-year zero-coupon security, and is the appropriate discount rate for the year 10

cash flow for a 20-year (or any maturity greater than or equal to 10 years) bond Spot rates are used to value bonds and to

ensure that bond prices eliminate any possibility for arbitrage resulting from buying a coupon security, stripping it of its coupons

and principal payment, and reselling the strips as separate zero-coupon securities The yield to maturity on a 10-year bond is the

(complex) average of the spot rates for all its cash flows

In which of the following conditions is the bond selling at a premium? The coupon rate:

current rate and yield-to-maturity are all the same.

is greater than current yield, which is greater than yield-to-maturity

is less than current yield, which is less than yield-to-maturity

Explanation

When a bond is selling at a premium the coupon rate will be greater than current yield and current yield will be greater than YTM

A $1,000 par value note is priced at an annualized discount of 1.5% based on a 360-day year and has 150 days to maturity The

note will have a bond equivalent yield that is:

Question #39 of 70 Question ID: 415605

The zero volatility spread (Z-spread) is the spread that:

results when the cost of the call option in percent is subtracted from the option adjusted

spread.

is added to the yield to maturity of a similar maturity government bond to equal the yield to maturity

of the risky bond

is added to each spot rate on the government yield curve that will cause the present value of the

bond's cash flows to equal its market price

Explanation

The zero volatility spread (Z-spread) is the interest rate that is added to each zero-coupon bond spot rate that will cause the

present value of the risky bond's cash flows to equal its market value The nominal spread is the spread that is added to the YTM

of a similar maturity government bond that will then equal the YTM of the risky bond The zero volatility spread (Z-spread) is the

spread that results when the cost of the call option in percent is added to the option adjusted spread

An investor buys a pure-discount note that matures in 146 days for $971 The bond-equivalent yield is closest to:

PG&E has a bond outstanding with a 7% semiannual coupon that is currently priced at $779.25 The bond has remaining

maturity of 10 years but has a first put date in 4 years at the par value of $1,000 Which of the following is closest to the yield to

first put on the bond?

14.46%.

7.73%

14.92%

Explanation

Question #42 of 70 Question ID: 485808

An investor purchases a 5-year, A-rated, 7.95% coupon, semiannual-pay corporate bond at a yield to maturity of 8.20% The

bond is callable at 102 in three years The bond's yield to call is closest to:

The current market required rate is less than the coupon rate.

The bond is selling at a discount

The bond is selling at a premium

Explanation

When the issue price is less than par, the bond is selling at a discount

We also know that the current market required rate is greater than the coupon rate because the bond is selling at a discount.

A bond-equivalent yield for a money market instrument is a(n):

discount yield based on a 365-day year.

add-on yield based on a 365-day year

discount yield based on a 360-day year

Explanation

A bond-equivalent yield is an add-on yield based on a 365-day year

Question #45 of 70 Question ID: 415536

A 2-year option-free bond (par value of $10,000) has an annual coupon of 15% An investor determines that the spot rate of year

1 is 16% and the year 2 spot rate is 17% Using the arbitrage-free valuation approach, the bond price is closest to:

$11,122.

$9,694

$8,401

Explanation

We can calculate the price of the bond by discounting each of the annual payments by the appropriate spot rate and finding the

sum of the present values Price = [1,500/(1.16)] + [11,500/(1.17) ] = $9,694 Or, in keeping with the notion that each cash flow is

a separate bond, sum the following transactions on your financial calculator:

N=1, I/Y=16.0, PMT=0, FV=1,500, CPT PV=1,293

N=2, I/Y=17.0, PMT=0, FV=11,500, CPT PV=8,401

Price = 1,293 + 8,401 = $9,694

An investor buys a 25-year, 10% annual pay bond for $900 and will sell the bond in 5 years when he estimates its yield will be

9% The price for which the investor expects to sell this bond is closest to:

The $900 purchase price is not relevant for this problem

Consider a $1,000-face value, 12-year, 8%, semiannual coupon bond with a YTM of 10.45% The change in value for a decrease

in yield of 38 basis points is:

Question #48 of 70 Question ID: 415594

Suppose the 3-year spot rate is 12.1% and the 2-year spot rate is 11.3% Which of the following statements concerning forward

and spot rates is most accurate? The 1-year:

forward rate two years from today is 13.2%.

forward rate two years from today is 13.7%

forward rate one year from today is 13.7%

Explanation

The equation for the three-year spot rate, S , is (1 + S )(1 + 1 1 )(1 + 2 1 ) = (1 + S ) Also, (1 + S )(1 + 1 1 ) = (1 + S ) So, (1

+ 2 1 ) = (1 + S ) / (1 + S ) , computed as: (1 + 0.121) / (1 + 0.113) = 1.137 Thus, 2 1 = 0.137, or 13.7%

Using the following spot rates, what is the price of a three-year bond with annual coupon payments of 5%?

Consider a 5-year, semiannual, 10% coupon bond with a maturity value of 1,000 selling for $1,081.11 The first call date is 3

years from now and the call price is $1,030 What is the yield-to-call?

Question #54 of 70 Question ID: 415516

An investor gathered the following information about two 7% annual-pay, option-free bonds:

Bond R has 4 years to maturity and is priced to yield 6%

Bond S has 7 years to maturity and is priced to yield 6%

Both bonds have a par value of $1,000

Given a 50 basis point parallel upward shift in interest rates, what is the value of the two-bond portfolio?

$2,030.

$2,044

$2,086

Explanation

Given the shift in interest rates, Bond R has a new value of $1,017 (N = 4; PMT = 70; FV = 1,000; I/Y = 6.50%; CPT ĺ PV =

1,017) Bond S's new value is $1,027 (N = 7; PMT = 70; FV = 1,000; I/Y = 6.50%; CPT ĺ PV = 1,027) After the increase in

interest rates, the new value of the two-bond portfolio is $2,044 (1,017 + 1,027)

A 20-year, 9% semi-annual coupon bond selling for $1,000 offers a yield to maturity of:

Randy Harris is contemplating whether to add a bond to his portfolio It is a semiannual, 6.5% bond with 7 years to maturity He is

concerned about the change in value due to interest rate fluctuations and would like to know the bond's value given various

scenarios At a yield to maturity of 7.5% or 5.0%, the bond's fair value is closest to:

A $1,000 par value, 10%, semiannual, 20-year debenture bond is currently selling for $1,100 What is this bond's current yield

and will the current yield be higher or lower than the yield to maturity?

Current Yield Current Yield vs YTM

The current yield will be between the coupon rate and the yield to maturity The bond is selling at a premium, so the YTM must be

less than the coupon rate, and therefore the current yield is greater than the YTM

The YTM is calculated as: FV = 1,000; PV = -1,100; N = 40; PMT = 50; CPT ĺ I = 4.46 × 2 = 8.92

A five-year bond with a 7.75% semiannual coupon currently trades at 101.245% of a par value of $1,000 Which of the following

is closest to the current yield on the bond?

7.75%.

7.53%

7.65%

Explanation

The current yield is computed as: (Annual Cash Coupon Payment) / (Current Bond Price) The annual coupon is: ($1,000)

(0.0775) = $77.50 The current yield is then: ($77.50) / ($1,012.45) = 0.0765 = 7.65%

Question #59 of 70 Question ID: 415577

The quoted margin of a floating-rate note is the number of basis points added to or subtracted from the note's reference rate to

determine its coupon payments The required margin or discount margin is the number of basis points above or below the

reference rate that would cause the note's price to return to par value at each reset date Required margin may be different from

quoted margin if a note's credit quality has changed since issuance

A 30-year, 10% annual coupon bond is sold at par It can be called at the end of 10 years for $1,100 What is the bond's yield to

The Treasury spot rate yield curve is closest to which of the following curves?

Par bond yield curve.