1. Which of the following bond price calculations is INCORRECT? An investor would pay:
A.$9684. 38 for a $10000 Treasury note quoted at 96 27/32.
B.$941.00 for a $1000 Treasury bond quoted at 94 10/32.
C.$956.25 for a $1000 corporate bond quoted at 95 20/32.
A B C
B
Bond prices are quoted in 32nds. A quote of 94 10/32=94.3125% , for a price of $943.125 for a $1000 Treasury bond. A quote of 96 27/32=96.84, for a price of $9684.38 for a $10000 bond. A quote of 95 20/32=95.625, for a price of $956.25 for a $1000 bond.
2. An analyst gathered the following information: Taxable security, quoted yield 9.8% Tax-exempt security, quoted yield 5.7% Investor's marginal tax rate 35% For the tax-exempt security, the investor's tax-equivalent yield is closest to
A.5.7%
B.8.8%
C.10.7%
A B C
B
5.7%/(1-35%)=8.8%.
3. Which of the following statements does NOT describe a characteristic of an illiquid asset or market ?
A.Large block trades that do not materially affect prices.
B.Wide bid-ask spreads.
C.Small trading volumes.
A B C
A
In a liquid market with large trading volumes, large block trades should not affect prices. All other choices are characteristics of illiquid markets or assets.
4. An investor is choosing between a 10% corporate bond and a 6% municipal bond with similar risk and similar maturity. What is the marginal tax rate that will make the investor indifferent between the two bonds?
A.0%.
B.30%.
C.40%.
A B C
C
10%×(1-x)=6%, x=40%.
5. Which of the following investors is least likely to have liquidity risk concerns? A:
A.financial institution heavily involved in the repurchase market.
B.portfolio manager for an emerging-market fund.
C.trader who invests exclusively in Treasury bonds.
A B C
C
6. A municipal bond selling at 12% above par offers a yield of 3.2%. A taxable Treasury note selling at an 8% discount offers a yield of 4. 6%. An investor in the 32.5% tax bracket wishes to purchase an equal dollar amount of both bonds. The after-tax yield of the two-bond portfolio is closest to:
A.2.63%.
B.3.90%.
C.3.15%.
A B C
C
The after-tax yield of the Treasury note is the stated yield times one minus the tax rate, or 4.6% times 67.5% , or 3.1%. To calculate the portfolio yield, take the average after-tax yields of both bonds, which is 3.15%.
7. Which of the following is TRUE about a bond with a deferred call provision?
A.It could be called at any time during the initial call period, but not later.
B.It could not be called right after the date of issue.
C.Principal repayment can be deferred until it reaches maturity.
A B C
B
A deferred call provision means the issue is initially (say, for the first 5 to 7 years) non-callable, after which time it becomes freely callable. In other words, there is a deferment period during which time the bond cannot be called, but after that, it becomes freely callable.
8. When determining credit risk spread, the benchmark security is most likely a(n):
A.Low-yield corporate bond.
B.Treasury bond.
C.AA rated bond.
A B C
B
The credit risk spread is measured in relation to a default-free security. Of the choices above, the security with the least chance of default is the Treasury bond. The AA rated bond is high quality, but not the highest quality (which would have an AAA rating). The low-yield corporate bond is a possibility, but it is not likely that this bond is as default-free as the Treasury security.
9. Benjamin Zoeller and Tara McGonigal are preparing for the Level I CFA examination. Zoeller is studying credit spread risk. McGonigal is farther along in her studies, but has forgotten how to determine the default free rate if given the yield on a bond rated BBB + of 9.50 percent and a risk premium of 3.00 percent. What does Zoeller tell her to use for the default free rate?
A.12.50%.
B.4.50%.
C.6.50%.
A B C
C
The formula for credit spread risk( or the yield on a risky asset) is: YieldRisky = YieldRF + Risk Premium, where RF = default - free rate. Rearranging this formula results in : YieldRF = YieldRisky = Risk Premium, or Yielder = 9.50%-3.00%=6.50%.
10. The liquidity preference theory holds that:
A.rational investors should show no preferences for either short- or long-term debt securities.
B.the yield curve should be upward-sloping.
C.cash should be preferred to Treasury securities because it is more liquid.
A B C
B
The liquidity preference theory definitely has an upward-sloping bias with regard to the shape of the yield curve. That is because it holds that investors generally prefer the greater liquidity and reduced risk that accompanies short-term securities and, as a result, require a premium (higher yields) to get them to invest in longer-term securities.
11. As compared to an equivalent non-put-able bond, a put-able bond's yield should be:
A.higher.
B.the same.
C.lower.
A B C
C
A put-able bond favors the buyer (investor). Hence, a premium will be paid for the option, which means the yield will be lower.
12. A bond issued by the government of Italy is likely to be denominated in which one of the following currencies?
A.U. S. dollars.
B.Swiss francs.
C.Euros.
A B C
C
Bonds issued by governments are likely to be denominated in the currency of the country where the bond is issued. In this case, the Euro is the Italian currency and bonds issued by the Italian government would normally be issued in Euros.
13. Which of the following is least likely allowed if a bond is non-refundable? A corporation:
A.issues zero coupon bonds at a yield that is lower than the current rate on their bonds and redeems the old bond issue.
B.calls its nonrefundable bonds and issues common equity in their place.
C.gets a revolving credit line at the bank at a rate lower than that on their bonds and redeems the bonds.
A B C
A
A company may refund debt as long as they do not issue cheaper debt to do so. The revolving credit line refunding situation is "gray," but the firm clearly could not issue the zero-coupon bonds.
14. Suppose a treasury inflation protective security (TIPS) is currently trading at its par value of $100000, and has a 4 percent coupon rate paid semi-annually. If the annual inflation rate is 2.5 percent, what is the coupon payment after six months has passed?
A.$2000.
B.$2025.
C.$2050.
A B C
B
This coupon payment is computed as follows: Coupon Payment =($100000×1.0125)×0.04/2=$2025.
15. The concept of spot and forward rates is most closely associated with which of the following explanations of the term structure of interest rates?
A.Segmented market theory.
B.Expectations hypothesis.
C.Liquidity premium theory.
A B C
B
16. A bond portfolio manager owns $ 5 million par valfie of a noncallable bond issue. The duration of the bonds is 5.6 and the current market value of the bonds is $5125000. If yield decline by 25 basis points, the approximate new price of the bonds after the decline in yield will be closest to:
A.$5053250.
B.$5070000.
C.$5196750.
A B C
C
Duration of 5.6 means that the approximate percentage price change for a 100 basis point change in yield will be 5.6%. A 25 basis point change would be 5.6/4=1.4%. The approximate new price would be $5125000×1.014=$5196750.
17. Which of the following statements about embedded options and yield volatility is FALSE?
A.As yield volatility increases, the value of the call option increases along with the value of the callable bond.
B.A call option benefits the issuer and a put option benefits the holder.
C.The greater the volatility of the underlying price, the greater the value of the embedded option.
A B C
A
As yield volatility increases, the value of the call option increases, and the value of the callable bond decreases and thus the bondholder loses. (As shown by the equation: Value of callable bond = Value of straight bond - Call option value. )
18. Which of the following institutions are federally-related institutions?
A.Student Loan Marketing Association.
B.Government National Mortgage Association.
C.Federal National Mortgage Association.
A B C
B
Federally-related (or government-owned) agencies are arms of the federal government. All other institutions listed are government-sponsored enterprises.
19. Generally speaking, all else being equal, an upward-sloping yield curve can be expected when:
A.inflationary expectations are beginning to subside and investors begin to show a preference for more liquid/less risky short-term securities.
B.the supply of long-term funds falls short of demand and investors begin to show a preference for more liquid/less risky short-term securities.
C.inflationary expectations are beginning to subside.
A B C
B
When demand for loanable funds outstrips supply, interest rates can be expected to rise in that (long-term) segment of the market; also, more preference for short-term securities can be expected to drive up long-term rates as the liquidity premium rises. Thus, both circumstances in the answer can be expected to put upward pressure on the long end of the yield curve.
20. John Harris earns $ 800000, and pays $200000 in taxes. His marginal tax rate is 40%. What would the taxable-equivalent yield be for John if he were to purchase a municipal bond with a yield of 3.25%?
A.4.33%.
B.5.42%.
C.3.25%.
A B C
B
3.25%/(1-40%)=5.42%.
21. The issuance of asset backed securities (ABSs) versus straight debt would be desirable if:
A.a better credit quality is desired on the asset backed versus the corporation.
B.there are regulatory constraints on the deal.
C.the corporation's credit rating may go up in the future.
A B C
A
K there are time constraints or regulatory issues, straight debt would be easier to issue. Also, if the corporation could be upgraded, it would benefit in straight debt but not its ABSs.
22. Which of the following is a general problem associated with external credit enhancements? External credit enhancements:
A.only provide protection against systematic risk, not against idiosyncratic risk.
B.are very long-term agreements and are therefore relatively expensive.
C.are subject to the credit risk of the third-party guarantor.
A B C
C
According to the "weak link" philosophy adopted by rating agencies, the credit quality of an issue can not be higher than the credit rating of the third-party guarantor. Along these lines, if the guarantor is downgraded, the issue itself could be subject to downgrade even if the structure is performing as expected.
23. Which of the following statements regarding mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs) is most likely correct?
A.MBS are created from CMOs.
B.Creating CMOs does not reduce the overall prepayment risk of a mortgage pass through security.
C.The prepayment option of an MBS benefits the security holder.
A B C
B
Creating a CMO can redistribute the prepayment risk among the tranches, but it does not alter the overall prepayment risk of a mortgage passthrough security. CMOs are created from MBS.
24. To reduce the cost of long-term borrowing, a corporation with a below average credit rating could:
A.issue asset backed securities.
B.decrease credit enhancement.
C.increase debt outstanding.
A B C
A
Commercial paper is a short-term promissory note. Increasing debt would increase the cost of borrowing.
25. According to the pure expectations theory, an upward-sloping yield curve implies:
A.interest rates are expected to decline in the future.
B.interest rates are expected to increase in the future.
C.longer-term bonds are riskier than short-term bonds.
A B C
B
According to the expectations hypothesis, the shape of the yield curve results from the interest rate expectations of market participants. More specifically, it holds that any long-term interest rate simply represents the geometric mean of current and future 1-year interest rates expected to prevail over the maturity of the issue.
26. Suppose that the one-year forward rate starting one year from now is 6%. Which of the following statements is TRUE under the pure expectations hypothesis? The expected:
A.future risk premium for short-term bills is 6%.
B.future one-year spot rate in one year's time is equal to 6%.
C.future risk premium for long-term bonds is 6%.
A B C
B
Under the pure expectations hypothesis, forward rates are equal to expected future spot rates.
27. Gabrielle Daniels and Edin Roth, CFA candidates, are discussing the relationship between a bond's coupon rate and the required market yield. Looking through the local newspaper, they see a new-issue, 10-year, $1000 face value 8.00 percent semi-annual coupon bond priced at $950. Daniels makes the following statements. Which statement does Roth tell her is CORRECT?
A.The current market required rate is less than the coupon rate.
B.The bond is selling at a premium.
C.The bond is selling at a discount.
A B C
C
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.
28. Which of the following institutions is NOT a government-sponsored enterprise (GSE)?
A.Government National Mortgage Association.
B.Student Loan Marketing Association.
C.Federal National Mortgage Association.
A B C
A
Federally-related (or government-owned) agencies are arms of the federal government. All other institutions listed are government-sponsored enterprises.
29. Which of the following statements about creating a collateralized mortgage obligation (CMO) is FALSE? A CMO:
A.redistributes the risk between the tranches on an unequal basis.
B.redistributes the risk between the tranches on a random basis.
C.does not affect the overall risk of prepayment.
A B C
B
Creating a CMO usually redistributes the risk between the tranches on an unequal basis, not on a random basis.
30. A coupon bond:
A.does not pay interest on a regular basis, but pays a lump sum at maturity.
B.can always be converted into a specific number of shares of common stock in the issuing company.
C.pays interest on a regular basis (typically semi-annually).
A B C
C
31. An investor most concerned with reinvestment risk would be least likely to:
A.eliminate reinvestment risk by holding a coupon bond until maturity.
B.prefer a lower coupon bond to a higher coupon bond.
C.be more concerned in a decreasing interest rate environment.
A B C
A
The key term here is coupon bond. While an investor in a fixed-coupon bond can usually eliminate price risk by holding a bond until maturity, the same is not true for reinvestment risk. The receipt of periodic coupon payments exposes the investor to reinvestment risk.
32. David Korotkin, CFA and a broker at an investment bank, has a client who is very concerned about maintaining purchasing power over the next year. The investor is conservative, and to date has been pleased with a consistent return of 8.00 percent. The bank's research department has estimated next year's inflation rate at 2.0 percent. The client specifically wants to invest in a fixed-coupon bond. Which of the following statements is most correct? If Korotkin purchases a bond with a 10.00 percent coupon, the client:
A.will realize a real gain.
B.will not lose purchasing power.
C.may lose purchasing power.
A B C
C
Investors want to be compensated for the inflation they expect plus for the risk that inflation will increase during the term of the investment. Here, the bank's estimated inflation rate is just that-an estimate. Thus, we cannot say for certain that the investor will not lose purchasing power. Inflation risk introduces uncertainty to the investment process.
33. Which of the following statements about currency risk is most accurate? Generally:
A.if the home currency appreciates against the foreign currency, each foreign currency unit will be worth more in terms of the home currency.
B.appreciation of the foreign currency is good for domestic investors who buy foreign securities.
C.if the foreign currency appreciates, the foreign cash flow will be worth less for the domestic investor.
A B C
B
If the home currency appreciates against the foreign (i. e. payment) currency, each foreign currency unit will be worth less in terms of the home currency. If the foreign currency appreciates, a given foreign cash flow will be worth more units of the home currency, thereby benefiting the domestic investor holding foreign securities.
34. Which of the following does NOT represent a primary market offering? When bonds are sold:
A.from a dealer's inventory.
B.on a best-efforts basis.
C.in a private placement.
A B C
A
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. 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.
35. A portfolio of option-free bonds is least likely to be exposed to
A.reinvestment risk.
B.interest rate risk.
C.volatility risk.
A B C
C
Volatility risk is the risk of that the price of a bond with an embedded option will decline when expected yield volatility changes. Option-free bond is net affected by Volatility risk.
36. Which of the following statements about special purpose vehicles (SPVs) is most accurate?
A.SPVs have no role in the asset backed credit rating process.
B.SPVs are used exclusively for asset backed transactions.
C.If bankruptcy occurs, a judge could rule that the SPVs assets can be considered general assets of the corporation.
A B C
C
Legal experts believe this is unlikely, but the issue is still a bit ambiguous legally.
37. Which of the following statements regarding Treasury bills (T-bills) is TRUE? T-bills:
A.have maturities greater than 6 months and can be sold at a price greater than par.
B.are considered the risk-free instrument, which means there exists no interest rate risk.
C.carry no coupon.
A B C
C
The maturities of T-bills range from 4 weeks to 6 months. T-bills are always sold on a discount basis. Risk-free means there is no credit risk, however, interest rate risk and price risk still exist.