CHAPTER 18
The Debt Markets
1.
are bonds backed by financial assets.
a. General obligation bonds
b. Debenture bonds
c. Common bonds
d. Collateral bonds
ANSWER: d
2.
are bonds with no collateral backing that have a general claim on the other
unpledged assets of the issuer.
a. General obligation bonds
b. Debenture bonds
c. Common bonds
d. Collateral bonds
ANSWER: b
3.
are a type of municipal bonds that are repaid out of general tax revenues.
a. General obligation bonds
b. Revenue bonds
c. Common bonds
d. Collateral bonds
ANSWER: a
4.
are a type of municipal bonds that are repaid out of the revenues from a specific
project that the bond supports.
a. General obligation bonds
b. Revenue bonds
c. Common bonds
d. Collateral bonds
ANSWER: b
5.
are bonds backed by real personal property such as residential or commercial
real estate.
a. General obligation bonds
b. Revenue bonds
c. Debenture bonds
d. Mortgage bonds
ANSWER: d
6. Which of the following are types of municipal bonds?
a. General obligation bonds
b. Revenue bonds
c. Debenture bonds
d. Both a and b
ANSWER: d
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7.
are debt securities that are backed by a pool of standardized mortgages, have a
low default risk, and provide a steady stream of income to the investor.
a. General obligation bonds
b. Mortgage-backed securities
c. Mortgage bonds
d. Collateral bonds
ANSWER: b
8. Which of the following types of securities are not backed by any real or financial assets?
a. Collateral bonds
b. Mortgage bonds
c. Debenture bonds
d. Mortgage-backed securities
ANSWER: c
9.
are bonds which lack collateral backing and have a general claim on the issuer
after debenture bondholders have been paid.
a. General obligation bonds
b. Revenue bonds
c. Debenture bonds
d. Subordinated debenture bonds
ANSWER: d
10.
are bonds whose principal amount is adjusted for inflation at the time when
coupon payments are made. The coupon payment is based on the inflation-adjusted principal.
a. General obligation bonds
b. Revenue bonds
c. Inflation-indexed bonds
d. Subordinated debenture bonds
ANSWER: c
11.
are a type of government security that allows investors to register and trade
ownership of the interest (coupon) payments and the principal amount of the security.
a. General obligation bonds
b. Revenue bonds
c. Treasury STRIPS
d. Subordinated debenture bonds
ANSWER: c
12. A written agreement setting forth the maturity date, interest rate, and other terms of the bond
issue is called the
a. bond indenture.
b. subordinated debenture.
c. load.
d. debenture bond.
ANSWER: a
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13. An investor seeking the highest possible return and who is willing to live with a great deal of risk
would be best served by which of the following types of mutual funds?
a. High Yield Bond Funds
b. Balanced Funds
c. U.S. Government Income Funds
d. Ginnie Mae Funds
ANSWER: a
14. Other factors equal, which of the following types of debt instruments is likely to pay the highest
return?
a. Debenture bonds
b. Subordinated debenture bonds
c. Mortgage bonds
d. Collateral bonds
ANSWER: b
15. Which of the debt instruments below is likely to pay the highest return?
a. Debenture bonds
b. Mortgage-backed securities
c. Mortgage bonds
d. Collateral bonds
ANSWER: a
16. The letter "n" following the maturity date in the Treasury securities market table indicates
a. its interest rate.
b. its asked price.
c. that the security is a note.
d. that the security is a net asset.
ANSWER: c
17. Assume that you are tracking one of your corporate bond holdings on the financial pages of The
Wall Street Journal. You notice in the far right-hand column that your company’s bond had a
“net change” of –1/8 for the day. What does this mean?
a. The interest rate on the bond has fallen by .125 percentage points.
b. The price of the bond has fallen $1.25 since the previous trading day.
c. The price of the bond has fallen by 1.25 percent since the previous trading day.
d. None of the above
ANSWER: b
18. A bond’s coupon yield will be equal to its current yield
a. whenever the bond is selling above its par value.
b. whenever the bond is selling below its par value.
c. whenever the bond is selling at its par value.
d. always.
ANSWER: c
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19. Assume that a particular Treasury security pays a coupon rate of 9 percent. The yield to maturity
on the bond is 5.75 percent. From this information we know that
a. the bond is selling at a discount.
b. the yield to maturity exceeds the coupon rate.
c. interest rates have risen since the bond was issued.
d. the bond is selling at a premium.
ANSWER: d
20. Assume that a particular Treasury security pays a coupon rate of 5.75 percent. The yield to
maturity on the bond is 9.0 percent. From this information we know that
a. the bond is selling at a discount.
b. the yield to maturity exceeds the coupon rate.
c. interest rates have risen since the bond was issued.
d. the bond is selling at a premium.
ANSWER: a
21. Which of the following statements best describes the relationship between stocks and bonds with
respect to risk and return?
a. Although bonds are riskier than stocks, bonds have historically earned a higher rate of return.
b. Even though there is a higher expected rate of return with bond ownership relative to stock
ownership, there is no guarantee that a higher return will be realized by any given instrument
or investor.
c. Although stocks are riskier than bonds, bonds have historically earned a higher rate of return.
d. Other things equal, ownership of stocks involves greater risk and greater expected return than
ownership of bonds or other financial assets.
ANSWER: d
22. If a city wants to raise funds to build a new baseball stadium and pay off the debt with revenues
raised through ticket and concession sales, which of the following types of securities should it
consider using?
a. Revenue bonds
b. General obligation bonds
c. Inflation-indexed bonds
d. Treasury STRIPS
ANSWER: a
23. If a city wants to raise funds to build a new city hall and pay off the debt with revenues raised
from sales taxes, which of the following types of securities should it consider using?
a. Revenue bonds
b. General obligation bonds
c. Inflation-indexed bonds
d. Treasury STRIPS
ANSWER: b
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24. Which of the following statements best describes the relationship among Treasury bills, notes,
and bonds?
a. Bills have an original maturity of one year or less. Notes have an original maturity of 2 to 10
years and bonds have an original maturity of greater than 10 years.
b. Notes have an original maturity of one year or less. Bills have an original maturity of 2 to 10
years and bonds have an original maturity of greater than 10 years.
c. Bonds have an original maturity of one year or less. Notes have an original maturity of 2 to
10 years and bills have an original maturity of greater than 10 years.
d. Bills have an original maturity of one year or less. Bonds have an original maturity of 2 to
10 years and notes have an original maturity of greater than 10 years.
ANSWER: a
25. Why have Ginnie Mae mortgage-backed securities become so popular with investors?
a. Because they have low interest rate risk.
b. Because they provide needed liquidity to the home mortgage market.
c. Because of the very low default risk created by the GNMA guarantee and the steady stream
of income provided.
d. Because of the high nominal returns compared to other debt securities.
ANSWER: c
26. If a bond sells for $1,050 and pays $75 in interest annually, what is its current yield?
a. 14 percent
b. 7.5 percent
c. 7.14 percent
d. The current yield cannot be found without knowing purchase price.
ANSWER: c
27. If a bond sells for $1,050 and pays $55 of interest annually, what is its current yield?
a. 10.5 percent
b. 5.24 percent
c. 5.5 percent
d. 19 percent
ANSWER: b
28. If a bond pays $75 in interest annually, at what price would it have to sell to have a current yield
of 7 percent?
a. $1,000.00
b. $1,071.43
c. $935.00
d. The current yield cannot be found without knowing purchase price.
ANSWER: b
29. The par value of a bond is $1,000, the coupon rate is 6 percent, and the current interest rate is 7
percent. What is the coupon payment?
a. $70
b. $60
c. $100
d. $65
ANSWER: b
30. Major credit-rating agencies that analyze and evaluate bonds and assign them to one of nine
classes based on the probability of default are
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a. Standard & Poors and Moody’s Investors Services
b. Fannie Mae
c. Freddie Mac
d. Ginnie Mae Investors Services
ANSWER: a
31. Which of the following is true?
a. U.S. corporate debt of nonfinancial firms has remained at roughly the same level for the past
25 years.
b. A corporation’s ability to service its debt would be called into question if it experienced a
decline in revenues or a spike in interest rates.
c. Outflows of capital from the United States have increased dramatically in recent years.
d. all of the above.
ANSWER: b
32. The ________________ is an expert in interpreting the provisions of an offering of new bonds
for the investor.
a. underwriter
b. account executive
c. trustee
d. bond rater
ANSWER: c
33. Bonds that do not make coupon payments and are sold at a discount with the difference between
the amount paid for the bond and the amount received at maturity equal to the interest are called
a. zero-coupon bonds.
b. Ginnie Mae bonds.
c. debenture bonds.
d. subordinated bonds.
ANSWER: a
34. Which of the following is false?
a. U.S. government bonds are issued by the Bureau of the Public Debt in minimum amounts of
$1,000 and sold in regularly scheduled competitive auctions.
b. Treasury bonds are a full faith and credit obligation of the U.S. government and are free from
interest rate and default risk.
c. The secondary market in Treasury bonds is an over-the-counter market formed by a group of
government securities dealers.
d. Interest earned on Treasury bonds is exempt from state income taxes.
ANSWER: b
35. Which of the following is a risk of investing in mortgages?
a. default risk
b. prepayment risk
c. interest rate risk
d. All of the above
ANSWER: d
36. Mortgage loans made by financial institutions or mortgage brokers without federal insurance are
called
a. fixed rate mortgages.
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263
b. uninsured mortgages.
c. secondary mortgages.
d. conventional mortgages.
ANSWER: d
37. To hedge the risk that mortgages will be prepaid before they mature because the property is sold
or refinanced, an investor should purchase
a. mortgage-backed securities.
b. Collateralized mortgage obligations.
c. FHA insured mortgages.
d. VA insured mortgages.
ANSWER: b
38. _______________________ are bonds issued by private enterprises that were publicly chartered
by Congress to reduce the cost of borrowing to certain sectors of the economy such as farming,
housing, and student loans.
a. General obligation bonds
b. Government agencies securities
c. Revenue bonds
d. Treasury STRIPS
ANSWER: b
39. _____________________ are private enterprises that were publicly chartered by Congress to
reduce the cost of borrowing to certain sectors of the economy such as farming, housing, and
student loans.
a. Government-owned enterprises
b. Government-sponsored enterprises
c. Federal Housing Administrations
d. Collaterized Mortgage Organizations
ANSWER: b
40. The formula used to determine the discount factor in finding the price of a bond is
a. d = Rf + Rp
b. d = Rf – Rp
c. d = Rf x Rp
d. d = Rf/Rp
ANSWER: a
41. The formula used to determine the discount factor in finding the price of a mortgage is
a. d = Rf + Rp + rsc
b. d = Rf – Rp - rsc
c. d = Rf x Rp+ rsc
d. d = Rf/Rp x rsc
ANSWER: a
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42. The risk premium for mortgages includes all of the following except that
a. the borrower will default.
b. the loan will be prepaid early.
c. the cost of servicing the mortgages rises.
d. the lower liquidity of mortgages compared to Treasury securities will cause the lender to
experience losses.
ANSWER: c
43. Which of the following factors affect the risk free rate?
a. the stance of monetary policy
b. changes in inflationary expectations, the economic outlook and the level of economic activity
c. changes in government borrowing
d. All of the above
ANSWER: d
44. _________________ is the paying off of the principal of a loan over the life of the loan.
a. Prepayment
b. Collaterization
c. Amortization
d. Securitization
ANSWER: c
45. Which of the following is false?
a. Bonds and mortgages are the major long-term financial instruments of the debt market.
b. The longer the term to maturity, the greater the change in price for any change in the interest
rate.
c. Moody’s and Standards & Poor’s assign ratings to corporate bonds but not to municipal
securities.
d. The issuer of bonds may be the U.S. government, an agency of the government, a state or
local government, a domestic or foreign corporation, or a foreign government.
ANSWER: c
46. Which of the following is true?
a. The largest debt market in the United States is the mortgage market.
b. The largest debt market in the United States is the corporate bond market.
c. The largest debt market in the United States is the government bond market
d. The largest debt market in the United States is the stock market.
ANSWER: a
47. If I was most concerned about risk, which of the following type of bond would I purchase?
a. debenture bonds
b. subordinated bonds
c. zero-coupon bonds
d. mortgage bonds
ANSWER: d
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48. The advantage to owning zero-coupon bonds is that
a. there is no risk that the interest over the life of the bond will have to be reinvested.
b. they are insured by the federal government and hence default risk is zero.
c. their coupon payments are made annually instead of semi-annually.
d. interest payments are not taxed on the amount of the interest earned each year.
ANSWER: a
49. Which of the following is false?
a. The secondary market in bonds is a loosely connected array of brokers and dealers who buy,
sell, and take positions in bonds in an over-the-counter market.
b. Although most bonds are sold over-the-counter, some bonds are also sold on organized
exchanges such as the New York Stock Exchange.
c. Over things being equal, the greater the expected liquidity on a bond, the lower the bond
yield.
d. A disadvantage of zero-coupon bonds for the issuing corporation is that the interest that is
paid each year cannot be written off by the corporation until the bond matures.
ANSWER: d
50 A seasoned bond is
a. a “used” bond that sells in the secondary market.
b. a new bond that is sold by a corporation that has previously issued bonds.
c. traded on the New York Stock Exchange.
d. backed by both real and financial assets.
ANSWER: a
51. Which of the following is false?
a. Treasury bonds are a full faith and credit obligation of the U.S. government and are hence
free of interest rate risk.
b. The secondary market in Treasury bonds is an over-the-counter market.
c. Treasury STRIPS allow investors to register and trade ownership of the interest (coupon)
payments and the principal amount of the security.
d. The principal of an in inflation-index bond is adjusted for inflation at the time when coupon
payments are made.
ANSWER: a
52. An inflation-index bond is one where the
a. coupon rate is adjusted every six months for changes in inflation.
b. interest payments every six months are adjusted for inflation based on the inflation-adjusted
coupon rate.
c. principal amount is adjusted for inflation at the time when a coupon payment is made,
usually every six months.
d. None of the above.
ANSWER: c
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53. Which of the following is false?
a. The issuer of municipal bonds is able to borrow at a lower rate than if interest would have to
be paid on the interest earned.
b. The interest on municipal securities is exempt from all federal taxes and state taxes.
c. Municipal bonds are issued by state, county, and local governments to finance public
projects such as schools, utilities, roads, and transportation projects.
d. Municipal bonds are particularly attractive to taxpayers in high income tax brackets.
ANSWER: b
54. If the rate on a comparable corporate bonds is 8 percent, and the average marginal tax rate is 25
percent, in equilibrium, the rate on municipal bonds would be
a. 2 percent.
b. 4 percent.
c. 10 percent.
d. 6 percent.
ANSWER: d
55. If the rate on a comparable corporate bond is 8 percent, and, in equilibrium, the rate on
municipal bonds is 6 percent, what is the average marginal tax rate?
a. 25 percent.
b. 14 percent.
c. 10 percent.
d. 2 percent.
ANSWER: a
56. Which of the following is false?
a. There have been some defaults on general obligation municipal bonds.
b. General obligation bonds are repaid out of general tax revenues.
c. Revenue bonds are paid back out of the cash flows of a particular project.
d. There have been some defaults on revenue bonds.
ANSWER: a
57. Which of the following is false?
a. Payments of principal and interest of securities of government-sponsored enterprises are
guaranteed by the federal government.
b. Areas where government-sponsored enterprises have been established include housing,
farming, the savings and loan industry, and student loans.
c. Government-sponsored enterprises are privately owned and issue long-term securities.
d. Government-sponsored enterprises have experienced tremendous growth since the 1990s.
ANSWER: a
58. A ______________ is a long-term debt instrument for which real estate is used as collateral to
secure the loan in the event of a default by the borrower.
a. collateral bond
b. mortgage
c. government agency security
d. debenture bond
ANSWER: b
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59. Which of the following is true?
a. Mortgages are assets to the holder and liabilities to the borrower.
b. Lenders are exposed to an interest rate risk when they invest in fixed rate mortgages.
c. Variable-rate mortgages reduce the interest rate risk of holding long-term mortgages.
d. All of the above.
ANSWER: d
60. Which of the following risk pertains to mortgages more than to other long term financial
instruments?
a. default risk
b. interest rate risk
c. prepayment risk
d. liquidity risk
ANSWER: c
61. Which of the following is false?
a. The longer the term-to-maturity on a mortgage, the smaller the default risk.
b. If interest rates rise, the default risk on variable rate loans increases.
c. The lower the down payment, the greater the default risk.
d. Variable rate loans reduce the interest rate risk.
ANSWER: a
62. The ________________ is much less for variable rate mortgages than for fixed rate mortgages.
a. default risk
b. interest rate risk
c. prepayment risk
d. both b and c
ANSWER: d
63. The _________________ is the risk that mortgages will be paid off early and the funds will have
to be reinvested at a lower return.
a. default risk
b. interest rate risk
c. liquidity risk
d. prepayment risk
ANSWER: d
64. _________________ is where the repayment of the principal on a mortgage is generally spread
out over the life of the loan.
a. Amortization
b. Collateralization
c. Securitization
d. Indexation
ANSWER: a
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65. Which of the following is false?
a. Conventional loans never have mortgage insurance.
b. Conventional loans are made by financial institutions and mortgage brokers without federal
insurance.
c. The interest rate on variable rate mortgages is adjusted as market rates change.
d. The principal of a mortgage is generally amortized over the life of the loan.
ANSWER: a
66. _______________________________ redirect the principal and interest payments of mortgagebacked securities to various classes of bondholders, thereby creating financial instruments with
varying prepayment risks.
a. Securitizations
b. Collateralized mortgage obligations
c. VA and FHA insured mortgages
d. Secondary markets
ANSWER: b
67. In finding the price of a previously issued bond, the appropriate _______________ is the current
interest rate on a security of equal risk, liquidity, and maturity.
a. yield
b. discount factor
c. price
d. coupon payment
ANSWER: b
68. The risk premium for bonds is based on all of the following except
a. risk-free return
b. the level of economic activity
c. the capital structure of the firm
d. firm and industry specific conditions
ANSWER: a
69. The _______________________ leveraged the firm, the _________________ the default risk,
other factors equal.
a. more highly; less
b. more highly; greater
c. less highly; greater
d. less; greater
ANSWER: a
70. Which of the following is true?
a. The remaining monthly payments and the current discount factor determine the present value
of a mortgage and hence the price at which the mortgage will trade.
b. The risk-free return is composed of the return on a Treasury security of comparable maturity.
c. If the value of mortgages falls—say because of declining real estate values or increasing
interest rates—the asset side of bank balance sheets falls. However, the liabilities of a bank
(i.e., deposits) do not fall. This may result in a bank’s (or the banking system’s) liabilities
becoming greater than its assets.
d. All of the above.
ANSWER: d
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71. Which of the following affects the discount factor for mortgages but not the discount factor for
bonds?
a. any factor that affects servicing costs such as changes in technology
b. any factor that affects the risk-free turn
c. any factor that affects the risk-premium
d. the stance of monetary policy and changes in inflationary expectations
ANSWER: a