1. Which of the following statements accurately describes direct and dealer paper?
A.The majority of direct paper issuers are financial companies.
B.Direct paper is rated, whereas dealer paper is not.
C.Direct paper tends to incur more issue costs versus dealer paper.
A B C
A
Dealer paper is issued via agents, whereas direct paper is issued directly by the issuer. Both types of commercial paper are rated. Since it is issued directly by the company, direct paper is less expensive to issue.
2. A CDO issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as a(n):
A.balance sheet CDO.
B.arbitrage CDO.
C.spread CDO.
A B C
B
A CDO (collaterized debt obligation) issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as an arbitrage CDO. A balance sheet CDO is created by a bank or insurance company wishing to reduce their loan exposure on the balance sheet. The other types of CDOs are fabricated terms.
3. The annual Fixed Income Analysts' Forum had just ended and two attendees, James Purcell and Frederick Hanes, were discussing some of the comments made by the panelists. Purcell and Hanes were specifically concerned with the following two statements that were made: Panelist 1: Mortgage-backed securities and asset-backed securities are both fixed income securities that are backed by pools of loans and are said to be amortizing securities. For many of the loans, no principal payments are required to be made prior to the maturity date. These securities are said to have a bullet maturity structure. Panelist 2: If coupon Treasury bonds or corporate bonds are issued with the terms specifying that the principal be repaid over time at the option of the issuer, then these bonds are putable bonds; if the principal is to be repaid over time at the option of the bondholder, then the bonds are termed callable bonds. Are the statements made by Panelist 1 and Panelist 2 correct? Panelist 1 Panelist 2 ①A. Correct Correct ②B. Correct Incorrect ③C. Incorrect Incorrect A. ①B. ②C. ③
A B C
C
Panelist 1 is incorrect. These securities do not have a bullet maturity structure. The payments are structured so that the loan is paid off when the last loan payment is made. Panelist 2 is incorrect. If coupon Treasury bonds or corporate bonds are issued with the terms specifying that the principal be repaid over time at the option of the issuer, then these bonds are callable bonds the call provision grants the issuer an option to retire part of the issue or the entire issue prior to the maturity date. On the other hand, if the principal is to be repaid over time at the option of the bondholder, then these bonds are put-able bonds - the put provision entitles the bondholder to put (sell) the issue back to the issuer at the put price (if interest rates increase and the bond's price declines below the put price).
4. An investor is considering floating-rate debt and other investments to protect against unexpected increases in inflation. Her friend suggests Treasury Inflation Protected Securities (TIPS) because the coupon rate is adjusted for inflation semiannually. The friend also states on-the-run Treasury issues have narrower bid-ask spreads than other Treasury issues. Should the investor agree or disagree with the friend's statements about TIPS and on-the-run issues? TIPS On-the-run issues ①A. Agree Agree ②B. Agree Disagree ③C. Disagree Agree A. ①B. ②C. ③
A B C
C
The friend is incorrect about the TIPS (the coupon rate is fixed, the par value is adjusted for inflation) and is correct about the bid-ask spread for on-the-run issues (on-the-run issues are more liquid and thus have a narrower bid-ask spread).
5. If an investor wants only investment grade bonds in her portfolio, she would be least likely to purchase a(n):
A.A-rated municipal bond.
B.3-year municipal bond rated BB.
C.10-year zero-coupon corporate bond rated AAA.
A B C
B
Investment grade bonds are BBB and above. This bond is rated BB, which is below BBB.
6. If expected yield volatility increases, the price of a(n)
A.put-able bond will increase.
B.callable bond will increase.
C.embedded put option will decrease.
A B C
A
Increasing yield volatility increases the value of both put options and call options, which decreases the value of a put-able bond but decreases the value of a callable bond.
7. Which of the following statements regarding a sinking fund provision is TRUE? A sinking fund provision:
A.requires that the issuer should set aside money based on a predefined schedule to accumulate the cash to retire the bonds at maturity.
B.requires that the issuer should retire a portion of the principal through a series of predefined principal payments over the life of the bond.
C.must be made through the payment of cash, paid to the trustee based on a predetermined schedule.
A B C
B
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. Sinking fund provisions provide for the repayment of principal through a series of payments over the life of the issue.
8. According to the expectations hypothesis, investors' expectations of decreasing inflation will result in:
A.a downward-sloping yield curve.
B.an upward-sloping yield curve.
C.a flat yield curve.
A B C
A
The expectations hypothesis holds that the shape of the yield curve reflects investor expectations about the future behavior of inflation and market interest rates. Thus, if investors believe inflation wilt be slowing down in the future, they will require lower long-term rates today and, therefore, the yield curve will be downward-sloping.
9. Which of the following embedded options benefits the bond investor?
A.Call provision.
B.Put provision.
C.Accelerated sinking fund provision.
A B C
B
A put provision allows the investor to put the bond back to the issuer.
10. Consider three municipal bonds issued by the Greater Holmen Metropolitan Capital Improvement District, a local authority that carries an issuer rating of single-A from the major debt rating agencies. All three bonds have the same coupon rate and maturity date. Series W was issued to finance the rebuilding and expansion of local schools and is backed by the District's authority to levy property tax. Series X was issued to build a water purification plant for the region. The District charges fees to the surrounding municipalities for their use of the plant. These fees are the only source of the interest and principal payments on the bonds. Series Y was issued to raise funds for the general use of the District in its ordinary maintenance projects and is backed by the District's authority to levy property tax. These bonds carry a third party guarantee of principal and interest payments. What is most likely the order of the market yields on these three bond issues, from highest to lowest?
A.Series Y, Series W, Series X.
B.Series W, Series X, Series Y.
C.Series X, Series W, Series Y.
A B C
C
Series X is a revenue bond. Because they pay interest and principal only if revenues from the project they finance are sufficient, revenue bonds are typically riskier and therefore have higher market yields than general obligation bonds. Series Y is an insured bond. Municipal bond insurance typically results in a higher rating, and therefore a lower market yield, than an equivalent bond from the same municipal issuer. So of these three bonds, Series X should have the highest market yield and Series Y the lowest.
11. Which of the following statements about debt securities is most likely correct?
A.A collateralized mortgage obligation is a derivative of a passthrough security with a payment structure that redistributes risk among investors in various tranches.
B.Insured bonds are bonds collateralized by an escrow of securities guaranteed by the U. S. government.
C.Tax-backed municipal bonds are supported through revenues generated from projects that are funded in whole or in part with the proceeds of the original bond issue.
A B C
A
Prefunded municipal bonds are bonds collateralized by an escrow of securities guaranteed by the U. S. government. Revenue bonds are supported through revenues generated from projects that are funded with the proceeds of the original bond issue.
12. Which of the following statements about asset backed securities (ABSs) is most accurate?
A.The credit rating of an ABS must be the same as that of the issuer.
B.Residential mortgages represent the largest type of asset that has been securitized.
C.There is an inverse relationship between credit enhancements and ratings.
A B C
B
The credit rating of an ABS pool is a function of its credit enhancements, which are quite common. The more credit enhancements, the higher the ratings.
13. A corporation may issue asset backed securities because:
A.All of the reasons are valid.
B.it wants to change the structure of its balance sheet.
C.it wants to speed up cash flows from the assets.
A B C
A
14. Tom Wilkens is a portfolio manager and has a retiree as a client. The client would like to invest in bonds with low interest rate risk. Which bond should Tom choose for his client? The bond with a:
A.20 year maturity and a yield to maturity of 5%.
B.10 year maturity and a yield to maturity of 8%.
C.10 year maturity and a yield to maturity of 5%.
A B C
B
The shorter the bond's maturity and the higher the yield to maturity, the shorter the duration and the lower the interest rate risk.
15. Which of the following statements about special purpose vehicles (SPVs) is least accurate?
A.SPVs are also known as bankruptcy remote entities and allow the asset backed security pool to have a higher credit rating than the issuing entity.
B.SPVs shield the assets of the asset backed security from creditors.
C.They are only used in asset backed security transactions.
A B C
C
16. Which of the following statements about the risks associated with investing in bonds is most accurate?
A.Corporate debentures are not subject to prepayment risk.
B.Liquidity risk is not relevant if the portfolio manager intends to hold the bond to maturity.
C.All fixed income securities except short-term Treasury bills are subject to volatility risk to some degree.
A B C
A
Only amortizing securities with a prepayment option are subject to prepayment risk. Volatility risk only applies to bonds that have embedded options. Liquidity risk can be important even for a bond held to maturity if the portfolio manager needs to mark its holdings to market for performance reporting purposes. Low liquidity for the bond can mean the prevailing price is not an accurate measure of the bond's value.
17. As part of his job at an investment banking firm, Damian O'Connor, CFA, needs to calculate the value of bonds that contain a call option. Today, he must value a 10-year, 7.50 percent annual coupon bond callable in five years priced at 96.5 (prices are stated as a percentage of par). A straight bond that is similar in all other aspects as the callable bond is priced at 99.0. Which of the following is closest to the value of the call option?
A.2.5.
B.3.5.
C.1.0.
A B C
A
To calculate the option value, rearrange the formula for a callable bond to look like: Value of embedded call option = Value of straight bond - Callable bond value Value of call option = 99.0-96.5=2.5. Remember: The call option is of value to the issuer, not the holder.
18. Which of the following statements regarding financing bond purchases with margin accounts is FALSE?
A.The required margin percentage changes daily.
B.Individuals are more likely than institutions to use margin accounts to finance bond purchases.
C.In the U. S. , margin accounts are regulated by the Federal Reserve.
A B C
A
The margin percentage is fixed by contract. The required margin dollars may vary from day to day due to fluctuations in the underlying collateral.
19. Which of the following statements about zero-coupon bonds is FALSE?
A.The lower the price, the greater the return for a given maturity.
B.A zero-coupon bond provides a single cash flow at maturity equal to its par value.
C.A zero coupon bond may sell at a premium to par when interest rates decline.
A B C
C
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.
20. Which of the following is least likely the reason that floating rate bonds may trade at prices different from their par values?
A.Resetting interest rates makes floating rate bonds more susceptible to the price risk that results from changing interest rates.
B.A time lag exists between the rate change in the market and the time when the coupon rate is reset.
C.The fixed quoted margin on the floating rate security may differ from the margin required by the market.
A B C
A
Resetting interest rates makes the bond less, not more, susceptible to interest rate changes.
21. Which of the following policy tools is the least likely to be available to the U. S. Federal Reserve Board?
A.Setting the discount rate at which banks can borrow from the Federal Reserve.
B.Requiring the banking system to tighten or loosen its credit policies.
C.Increasing or decreasing bank reserve requirements.
A B C
B
The U. S. Federal Reserve can encourage or persuade banks as a whole to tighten or loosen their credit policies, but it cannot compel them to do so.
22. If investors expect stable rates of inflation in the future, the pure expectations theory suggests that the yield curve now will be:
A.flat.
B.inverted.
C.humped.
A B C
A
The pure expectations theory explains the term structure in terms of expected future short-term interest rates. Assuming that interest rates reflect a relatively stable real rate of interest plus a premium for expected inflation, stability in inflation expectations would mean unchanged future short-term interest rates and a flat yield curve.
23. Which statement about the risks of bond investing is FALSE?
A.Issuers of revenue bonds are not always obligated to pay principal and interest.
B.Interest on some municipal bonds is not excluded from federal income taxes.
C.In a competitive Treasury-bill auction, not all bidders pay the same price.
A B C
C
All T-bills are auctioned using the single-price method, in which all-successful bidders pay the price implied by the stop yield, which is the yield at which the quality demanded equals the quantity for sale. Most municipal bonds are exempt from federal taxes, but not all of them. Revenue bond issuers are not required to meet their obligations unless the project backing the bonds generates enough revenue.
24. Which of the following statements about municipal bonds is FALSE?
A.A municipal bond guarantee is a form of insurance provided by a third party other than the issuer.
B.Revenue bonds have lower yields than general obligation bonds because there are more revenue bands and they have higher liquidity.
C.Bonds with municipal bond guarantees are more liquid in the secondary market and generally have lower required yields.
A B C
B
General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Revenue bonds are serviced by the income generated from specific income-producing projects and can not be paid from other proceeds unrelated to the project. Therefore, they are riskier than general obligation bonds.
25. Silhouette Enterprises must make a balloon loan payment of $1000000 in 3 years. The firm's treasurer wants to purchase a bond that will provide funds for repayment and minimize reinvestment risk. Assume the company has the following four investment options (all with face values of $1000000). Market rates are at 8.00 percent. All bonds are non-callable and are otherwise similar except as noted. Which option best meets the treasurer's requirements?
A.A 4-year, zero coupon bond priced to yield 8.50%.
B.A 3-year, 8.00% semi-annual coupon bond priced at par.
C.A 3-year, zero coupon bond priced to yield 8.00%.
A B C
C
The 3-year coupon bond fulfills the treasurer's requirement concerning funds for repayment, it does not minimize reinvestment risk. Among the zero-coupon bonds, the one that best matches the loan's maturity will minimize reinvestment risk. The treasurer will thus prefer the 3-year, zero-coupon bond. ff he purchased the 4-year zero-coupon bond, he would have to sell the bond prior to maturity to payoff the loan and would face price risk.
26. Which of the following statements regarding zero-coupon bonds and spot interest rates is TRUE?
A.Price appreciation creates all of the zero-coupon bond's return.
B.Spot interest rates will never vary across the term structure.
C.If the yield to maturity on a 2-year zero coupon bond is 6%, then the 2-year spot rate is 3%.
A B C
A
Because zero-coupon bonds have no coupons (all of the bond's return comes from price appreciation), investors have no uncertainty about the rate at which coupons will be invested. Spot rates are defined as interest rates used to discount a single cash flow to be received in the future. If the yield to maturity on a 2-year zero is 607o, we can say that the 2-year spot rate is 6%.
27. A debt security that is collateralized by various corporate bonds would be a(n):
A.CMO.
B.CDO.
C.ABS.
A B C
B
A CDO (collaterized debt obligation) is a debt obligation that is backed by an underlying diversified pool of business loans, mortgages, emerging market debt, corporate bonds, asset-backed securities, or non-performing loans. An ABS (asset-backed security) is a debt obligation that is backed by credit card debt, auto loans, bank loans, and corporate receivables. A CMO (collaterized mortgage obligation) is a debt obligation that is backed by mortgages.
28. Which of the following investors is least susceptible to inflation risk?
A.A financial institution with assets concentrated in fixed-rate mortgages.
B.An individual with a 5 year certificate of deposit at a local financial institution.
C.The holder of a 15-year bond with a coupon formula equal to the U. S. prime rate plus 3.25%.
A B C
C
A 15-year bond with a coupon formula equal to the U. S. prime rate plus 3.25% is an example of a floating rate bond. The holder of an adjustable rate asset is impacted less by inflation than the holder of a fixed-rate asset because the increased cash flow (from the higher coupon payments when the base rate increases) at least partially offsets the decreased purchasing power caused by inflation.
29. All other things being equal, which one of the following bonds has the greatest duration?
A.15-year, 8% coupon bond.
B.5-year, 8% coupon bond.
C.15-year, 12% coupon bond.
A B C
A
If bonds are identical except for maturity and coupon, the one with the longest maturity and lowest coupon wilt have the greatest duration. The rationale for this is similar to that for price volatility. The later the cash flows are received, the greater the duration. The longer the time to maturity, the greater the duration. A longer-term bond pays its cash flows later than a shorter-term bond, increasing the duration. Here, one of the 15-year bonds will have the greatest duration. The lower the coupon rate, the greater the duration. A lower coupon bond pays lower annual cash flows than a higher-coupon bond and thus has less influence on duration. Here, the 15-year bond with the lowest coupon (8.00%) will have the greatest duration.
30. The Treasury spot rate yield curve is closest to which of the following curves?
A.Par bond yield curve.
B.Zero-coupon bond yield curve.
C.Reinvestment rate yield curve.
A B C
B
The spot rate yield curve shows the appropriate rates for discounting single cash flows occuring at different times in the future. Conceptually, these rates are equivalent to yields on zero-coupon bonds. The par bond yield curve shows the YTMs on coupon bonds by maturity. Forward rates are expected future short-term rates. Reinvestment rates are not part of the spot rate yield curve.
31. A 6% annual coupon paying bond has two years remaining to maturity and is priced at par. Assuming a 40% tax rate, the after-tax yield for this bond is closest to:
A.2.4%.
B.3.6%.
C.4.8%.
A B C
B
Since the bond is trading at par, its yield to maturity is equal to its coupon rate of 6.0%. The after-tax yield is (1-0.4)×(6.0%)=3.6%.
32. Jori England, CFA candidate, is studying the value of callable bonds. She has the following information: a callable bond with a call option value calculated at 1.75 (prices are quoted as a percent of par) and a straight bond similar in all other aspects priced at 98.0. Which of the following choices is closest to what England calculates as the value for the callable bond?
A.96.25.
B.99.75.
C.96.0.
A B C
A
To calculate the callable bond value, use the following formula: Value of callable bond = Value of straight bond - Call option value Value of callable bond = 98.0-1.75=96.25.
33. The dirty, or full, price of a bond:
A.applies if an issuer has defaulted.
B.equals the present value of all cash flows, plus accrued interest.
C.is paid when a security trades ex-coupon.
A B C
B
The dirty price of a bond equals the quoted price plus accrued interest. If an issuer has defaulted, the bond trades without interest and is said to trade flat. When a security trades ex-coupon, the buyer pays the clean price, which is the quoted price without accrued interest. The dirty price of a bond is greater than the clean price by the amount of the accrued interest. (If the bond trades on a coupon date, the dirty price will equal the clean price. )
Use the following information for Questions. Peter is considering two bonds: Bond A yield 10% Bond B yield 7 %
34. Using Bond B as the reference bond, calculate the absolute yield spread.
A.-3.0%.
B.0%.
C.3%.
A B C
C
Absolute yield spread = Yield on Bond A- Yield on Bond B = 10%-7%=3%.
35. Using Bond B as the reference bond, calculate the relative yield spread.
A.40%.
B.43%.
C.47%.
A B C
B
Relative yield spread = (Yield on Bond A -Yield on Bond B)/( Yield on Bond B)=(10%-7%)/7%=0.43=43%.
36. Support for the revenue bonds comes from:
A.property taxes based on the project.
B.the gross revenues of the underlying project.
C.the net revenues of the underlying project.
A B C
C
Revenue bonds are serviced by the net income generated from specific income-producing projects (e. g. toll roads).
37. Credit risk is measured in several ways. The yield differential above the return on a benchmark security measures the:
A.default risk.
B.downgrade risk.
C.credit spread risk.
A B C
C
The yield differential above the return on a benchmark security measures the credit spread risk. Credit spread risk is also known as the risk premium or spread.
38. Which of the following statements concerning asset-backed securities (ABSs) is FALSE?
A.The asset-backed pool may be overcollateralized to provide a credit enhancement.
B.The assets are typically placed in a special purpose vehicle to shield them from the firm's creditors.
C.ABSs typically have lower debt ratings than the firm's other borrowings.
A B C
C
The objective of the firm with an ABS issue typically is to get a higher debt rating (a lower cost of borrowing). Typically, the ABS has a higher debt rating, perhaps because of credit enhancements.
39. A $1000 par, semiannual-pay bond is trading for 89.14, has a coupon rate of 8.75%, and accrued interest of $ 43.72. The clean price of the bond is:
A.$847.69.
B.$891.40.
C.$935.12.
A B C
B
The clean price of the bond is the quoted price, 89. 14% of par value, which is $891.40.
40. Which of the following statements about balancing reinvestment risk and price risk is TRUE? When interest rates:
A.decline, price risk decreases and reinvestment risk decreases.
B.rise, price risk increases and reinvestment risk increases.
C.decline, price risk decreases and reinvestment risk increases.
A B C
C
All else equal, reinvestment risk and price risk move in opposite directions. For example, when interest rates rise, bond prices decrease, but the loss is at least partially offset by decreased reinvestment risk (it is less likely that a bond will be called and bondholders can invest coupon payments at higher yields). When interest rates fall, price risk decreases because the bond value is rising and reinvestment risk increases because it is more likely that the issuer/ borrower will call the security and the bondholder must reinvest coupon payments at lower yields.
41. For a decline in interest rates, the price of a callable bond, when compared to an otherwise identical option-free bond, will most likely rise by:
A.less because the price of the embedded option rises.
B.less because the price of the embedded option falls.
C.more because the price of the embedded option rises.
A B C
A
As interest rates decline, the price of the option-free bond rises. However, the price Of the embedded call option also rises. Consequently, the price of a callable bond rises by less than the price of an otherwise identical option-free bond.
42. Paul Blackburn is describing mortgage backed securities and makes the following statements: Statement 1: A mortgage pass-through security is formed by pooling a large number of mortgages and issuing certificates that represent ownership shares in the pool. Because each mortgage borrower has the right to prepay the mortgage, the value of a pass-through security behaves as if the security has an embedded put feature. Statement 2: A collateralized mortgage obligation with sequential tranches is created by pooling mortgage pass-through certificates. Securities are issued in different tranches that have proportionate claims on the cash flows from the pass-through certificates. Are Blackburn's statements correct? Statement 1 Statement 2 ①A. Correct Correct ②B. Correct Incorrect ③C. Incorrect Incorrect A. ①B. ②C. ③
A B C
C
Statement 1 is incorrect. A borrower who prepays a mortgage is in effect exercising a call option, similar to a corporate bond issuer who calls a bond and prepays the principal. Therefore the pool of mortgages and the securities created from it behave as if they had an embedded call feature. Statement 2 is incorrect. Sequential tranches issued as a collateralized mortgage obligation do not have proportionate claims on the cash flows from the pool. Instead they have sequential claims. The shortest-term tranche receives principal and interest payments until it is paid off. The cash flows then go to the second tranche until it is paid off, and so on. This structure allows securities with different timing and risk profiles to be issued from the same pool of certificates.
43. If the slope of the yield curve begins to rise sharply, it is usually an indication that:
A.the rate of inflation is starting to increase or is expected to do so in the near future.
B.stocks are offering abnormally high rates of return.
C.the Fed has been aggressively driving up short-term interest rates.
A B C
A
According to the expectations hypothesis, higher long-term interest rates and, therefore, up-ward-sloping yield curves will occur if the rate of inflation starts to heat up or is expected to do so in the near future.
44. Price compression:
A.occurs when a bond's cap and floor are set close together.
B.occurs when demand for a bond is high near the first call date.
C.reduces the potential for price appreciation and benefits the issuer.
A B C
C
When a bond has a call provision, the potential for price appreciation is reduced, because the call caps the price of the bond near the call price, even if interest rates fall considerably. It is unlikely that investors would pay a price that exceeds the call price. Price compression benefits the issuer, because it allows the issuer to call the bond if interest rates decrease allowing the issuer to replace the existing debt with lower cost debt.
45. If investors expect future rates will be higher than current rates, the yield curve should be:
A.upward sweeping.
B.downward sweeping.
C.flat.
A B C
A
When interest rates are expected to go up in the future the yield curve will be upward sweeping because time is on the x-axis and rates are on the y-axis, thus forming an upward sweeping curve.
46. Which of the following statements regarding financing bond purchases is TRUE?
A.In margin transactions, the broker borrows from the bank at the call money rate plus a spread.
B.The rate the investor pays on the loan in a margin transaction is known as the call money rate.
C.Purchasing securities on margin allows investors to leverage assets and make larger purchases.
A B C
C
In margin transactions, the broker borrows from the bank at the call money rate. The rate the investor pays on the loan in a margin transaction is known as the call money rate plus a spread. Remember that the broker needs to make profit, so the investor will pay a rate higher than the broker pays to the bank. The investor collateralizes the margin loan with the securities purchased.
47. The liquidity preference theory of the term structure of interest rates implies that the shape of the yield curve should be:
A.flat or humped.
B.downward-sloping.
C.upward-sloping.
A B C
C
The liquidity preference theory definitely puts upward pressure on the long end of the term structure and, by itself, would lead to an upward-sloping yield curve.
48. Which of the following statements about how the features of a bond impact interest rate risk is FALSE?
A.Bond price movements depend upon the direction and magnitude of changes in interest rates.
B.All else equal, a longer-term bond is more sensitive to interest rates than a shorter-term bond.
C.An inverse relationship between interest rates and bond prices means that the greater the change in interest rates, the less the change in fixed-coupon bond prices.
A B C
C
The inverse relationship between interest rates and bond prices means that when interest rates increase, fixed-coupon bond prices decrease. In other words, the inverse relationship means that interest rates and bond prices move in opposite directions, it does not infer anything about the magnitude of the change.
49. Which of the following statements about different types of bonds is least likely correct?
A.Municipal bonds are traded primarily on the New York Stock Exchange.
B.Tax-backed bonds are backed by the full faith and credit of the issuer's entire taxing power.
C.Government-sponsored enterprises issue securities directly in the marketplace, but federally related institutions generally do not.
A B C
A
Municipal bonds are traded in the over-the-counter market supported by municipal bond dealers across the country.
50. Simone Girard, CFA candidate, is studying yield volatility and the value of callable bonds. She has the following information: a callable bond with a call option value calculated at 1.25 (prices are quoted as a percent of par) and a straight bond similar in all other aspects priced at 98.5. Girard also wants to determine how the bond's value will change if yield volatility increases. Which of the following choices is closest to what Girard calculates as the value for the callable bond and correctly describes the bond's price behavior as yield volatility increases?
A.97.25, price increases.
B.99.75, price decreases.
C.97.25, price decreases.
A B C
C
To calculate the callable bond value, use the following formula: Value of callable bond = Value of straight bond - Call option value =98.5-1.25=97.25. Remember: The call option is subtracted from the bond value because the call option is of value to the issuer, not the holder. As yield volatility increases, the value of the embedded option increases. The formula above shows that for a callable bond, an increase in the option value results in a decreased bond value.