CHAPTER 17—BOND FUNDAMENTALS

MULTIPLE CHOICE

1. The bond market segments that tend to be highly correlated and move together include
a. Short and long term bonds.
b. Short and intermediate term bonds.
c. Intermediate and long term bonds.
d. Short, intermediate and long term bonds.
e. None of the above.
ANS: D PTS: 1 OBJ: Multiple Choice

2. Of the following provisions that might be found in a bond indenture, which would tend to reduce the
coupon interest rate?
a. A call provision
b. No restrictive covenants
c. A sinking fund provision
d. Change in bond rating from Aaa to Aa
e. None of the above (that is, all will increase the coupon rate)
ANS: C PTS: 1 OBJ: Multiple Choice

3. The refunding provision of an indenture allows bonds to be retired unless

a. They are replaced with a lower coupon bond issue.
b. The remaining time to maturity is less than five years.
c. The remaining time to maturity is greater than five years.
d. The stated time period in the indenture has not passed.
e. The stated time period in the indenture has passed.
ANS: A PTS: 1 OBJ: Multiple Choice

4. Serial bonds
a. Can be callable.
b. Can have sinking funds.
c. Have different maturity dates.
d. All of the above.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

5. Which of the following statements is not true regarding bond ratings?

a. The ratings assigned are meant to indicate the probability of default for the bond issuer.
b. The bonds assigned one of the top four rating classes are considered investment grade
bonds.
c. Once a rating is assigned to an issue it cannot be changed for the first two years after
which it is reviewed on a regular basis.
d. Bonds rated BB and below are referred to as high yield or "junk" bonds.
e. The rating agencies modify the ratings with + and - signs or numbers after the letters.

ANS: C PTS: 1 OBJ: Multiple Choice

 6. When a fixed income security is being traded but the issuer is not meeting interest payments it is
trading
a. Stamped.
b. Registered.
c. Flat.
d. Round.
e. No accrual.
ANS: C PTS: 1 OBJ: Multiple Choice

7. Which type of bond is backed by the full faith and credit of the issuer and its entire taxing power?
a. Fannie Mae
b. Freddie Mac
c. GSEs
d. General obligation
e. Revenue
ANS: D PTS: 1 OBJ: Multiple Choice

8. The bonds issued by the Bank of England are known as

a. Gilts.
b. Bunds.
c. Limies.
d. Treasuries.
e. Benchmarks.
ANS: A PTS: 1 OBJ: Multiple Choice

9. When a bond issue is secured by a legal claim on equipment it is known as a(n)

a. Junior bond.
b. Income bond.
c. Bearer bond.
d. Trust certificate.
e. Perpetuity.
ANS: D PTS: 1 OBJ: Multiple Choice

10. Which set of conditions will result in a bond with the greatest volatility?
a. A high coupon and a short maturity
b. A high coupon and a long maturity
c. A low coupon and a short maturity
d. A low coupon and a long maturity
e. A deferred call feature and a sinking fund.
ANS: D PTS: 1 OBJ: Multiple Choice

11. The annual interest paid on a bond relative to its prevailing market price is called its
a. Promised yield.
b. Yield to maturity.
c. Coupon rate.
d. Effective yield.
e. Current yield.
ANS: E PTS: 1 OBJ: Multiple Choice
12. The institutions which invest most heavily in corporate bond issues are
a. Life insurance companies and commercial banks.
b. Life insurance companies and property and liability insurance companies.
c. Life insurance companies and pension funds.
d. Commercial banks and property and liability insurance companies.
e. Commercial banks and pension funds.
ANS: C PTS: 1 OBJ: Multiple Choice

13. Which of the following is not a major rating agency for bonds?
a. Moody's
b. Standard & Poor's
c. Fitch Investor Services
d. Value Line
e. Duff and Phelps
ANS: D PTS: 1 OBJ: Multiple Choice

14. Treasury bonds which can be purchased at a discount to be used at par to pay estate taxes are called
a. Estate bonds.
b. Flower bonds.
c. Municipal bonds.
d. Probate bonds.
e. Survivor bonds.
ANS: B PTS: 1 OBJ: Multiple Choice

15. The major owners of high-yield bonds have been

a. Commercial banks.
b. Savings and loans.
c. Mutual funds.
d. California Credit Unions (CCU's).
e. European banks.
ANS: C PTS: 1 OBJ: Multiple Choice

16. When a fixed income security is being traded at the price above its face value it is trading
a. At a discount.
b. At par.
c. At a premium.
d. Flat.
e. No accrual.
ANS: C PTS: 1 OBJ: Multiple Choice

17. A security that has a coupon that is periodically adjusted is a(n)

a. Variable note.
b. Variation note.
c. Adjustable coupon note.
d. Money market certificate.
e. Deep discount bond.
ANS: A PTS: 1 OBJ: Multiple Choice
18. The following are participating issuers in bond markets:
a. Governments.
b. School districts.
c. Corporations
d. a and c.
e. a, b and c.
ANS: E PTS: 1 OBJ: Multiple Choice

19. The following are participating investors in bond markets:

a. U.S. Treasury.
b. Life insurance companies.
c. Commercial banks.
d. a and b.
e. b and c.
ANS: E PTS: 1 OBJ: Multiple Choice

20. Institutional investors typically account for about

a. 90 to 95 percent of bond market trading.
b. 40 to 50 percent of bond market trading.
c. 10 to 15 percent of bond market trading.
d. Less than 5% of bond market trading.
e. None of the above.
ANS: A PTS: 1 OBJ: Multiple Choice

21. Alternative institutions favor different sectors of the bond market based on
a. The level of interest rates.
b. The tax code applicable to the institution.
c. The nature of the institution's asset structure
d. a and b.
e. b and c.
ANS: B PTS: 1 OBJ: Multiple Choice

22. Bond ratings are positively related to

a. Leverage.
b. Size.
c. Type of business.
d. All of the above.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

23. Bond ratings are negatively related to

a. Profitability.
b. Cash flow coverage.
c. Earnings instability.
d. All of the above.
e. None of the above.
ANS: C PTS: 1 OBJ: Multiple Choice
24. TIPS are U.S Treasury securities where the coupon rate is
a. Zero
b. Indexed to the rate of inflation.
c. Indexed to the discount rate.
d. Indexed to the prime rate.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

25. If the yield to maturity for a par value TIPS bond with 8 years to maturity is 3%, and the yield to
maturity of a U.S Treasury note with 8 years is 4.25%, this implies that
a. The expected annual rate of inflation over the next 8 years is -1.25%.
b. The expected annual rate of inflation over the next 8 years is 1.25%.
c. The expected annual rate of inflation over the next 8 years is -2.25%
d. The expected annual rate of inflation over the next 8 years is 2.25%
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

26. The face value of a U.S. government agency security

a. Is always $1000.
b. Ranges from $1000 to $5000.
c. Ranges from $1000 to $100,000.
d. Ranges from $1000 to $50,000.
e. Is always $10,000.
ANS: C PTS: 1 OBJ: Multiple Choice

27. A major source of risk faced by GNMA issues is

a. Default risk.
b. Prepayment risk.
c. Counterparty risk.
d. a and b.
e. a, b and c.
ANS: B PTS: 1 OBJ: Multiple Choice

28. When homeowners pay off mortgages when they sell their homes, or when homeowners refinance
home mortgages, they effectively
a. Make the maturities of GNMA securities longer.
b. Make the maturities of GNMA securities shorter.
c. Make the maturities of U.S. Treasury securities longer.
d. Make the maturities of U.S. Treasury securities shorter.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

29. General obligation bonds are

a. U.S. Treasury bonds backed by the full faith and credit of the issuer.
b. U.S. Treasury bonds backed by income generated form specific projects.
c. Municipal bonds backed by the full faith and credit of the issuer.
d. Municipal bonds backed by income generated from specific projects.
e. A type of U.S. agency security.
 ANS: C PTS: 1 OBJ: Multiple Choice

30. Revenue bonds are

a. U.S. Treasury bonds backed by the full faith and credit of the issuer.
b. U.S. Treasury bonds backed by income generated form specific projects.
c. Municipal bonds backed by the full faith and credit of the issuer.
d. Municipal bonds backed by income generated from specific projects.
e. A type of U.S. agency security.
ANS: D PTS: 1 OBJ: Multiple Choice

31. Collateralized Mortgage obligations are

a. Mortgage pass-through securities.
b. Mortgage pass-through securities with varying maturities.
c. Mortgage pass-through securities with no default risk.
d. Mortgage pass-through securities with variable coupon rates.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice

32. A bond denominated in U.S. dollars and sold in Japan to Japanese investors is called a
a. Samurai bond.
b. Eurobond.
c. Yankee bond.
d. Euroyen bond
e. Foreign bond.
ANS: B PTS: 1 OBJ: Multiple Choice

33. The legal document setting forth the obligations of a bond's issuer is called
a. A debenture.
b. A warrant.
c. An indenture.
d. A rights certificate.
e. A trustee deed.
ANS: C PTS: 1 OBJ: Multiple Choice

34. Collateralized mortgage obligations (CMOs) offset some of the problems associated with traditional
mortgage pass-throughs because
a. They are overcollateralized.
b. They have variable rates.
c. Collateralized by auto-loans.
d. They are deep discount instruments.
e. Collateralized by credit card debt.
ANS: A PTS: 1 OBJ: Multiple Choice

35. A bond that only pays a principal payment at maturity date is known as a(n):
a. Blank bond.
b. Maturity bond.
c. Interest free bond.
d. Mini-coupon bond.
 e. Zero coupon bond.
ANS: E PTS: 1 OBJ: Multiple Choice

36. What was developed in the early 1980s to offset some of the problems with traditional mortgage pass-
throughs?
a. Variable rate mortgages.
b. Collateralized mortgage obligations (CMOs)
c. Leveraged buyouts (LBOs)
d. Deep discount bonds (DDBs)
e. High yield bonds.
ANS: B PTS: 1 OBJ: Multiple Choice

37. Which of the following statements regarding Collateralized Debt Obligations (CDOs) is false?
a. CDOs experienced rapid growth since the year 2000.
b. The assets used to back the CDOs are substantially diverse.
c. The credit quality within a CDO at the time of issue is diverse.
d. CDOs have generated significant credit and liquidity problems.
e. All of the above statements are true.
ANS: E PTS: 1 OBJ: Multiple Choice

38. A U.S. dollar-denominated bond sold in the United States by a Japanese-firm is called a(n):
a. Yankee bond.
b. Homeland bond.
c. International bond.
d. U.S. Domestic bond.
e. Japanese U.S. Regional bond.
ANS: A PTS: 1 OBJ: Multiple Choice

39. Which of the following entities acquire mortgages and create mortgage backed securities?
a. Federal National Mortgage Association (Fannie Mae)
b. Government National Mortgage Association (Ginnie Mae)
c. Federal Home Loan Mortgage Corporation (Freddie Mac)
d. All of the above.
e. None of the above.
ANS: D PTS: 1 OBJ: Multiple Choice

40. When a borrower pledges financial assets as collateral for a bond it is called a(n)
a. Mortgage bond.
b. Equipment trust certificate.
c. Mortgage pass-through security.
d. Collateral trust bond.
e. Collateralized mortgage obligation (CMO).
ANS: D PTS: 1 OBJ: Multiple Choice

41. Issues that provide funds to retire another issue early are known as
a. Bearer bonds
b. Secured debentures
c. Unsecured debentures
 d. Revenue bonds
e. Refunding bonds
ANS: E PTS: 1 OBJ: Multiple Choice

42. Which bond provision would be considered the most risky for an investor who is concerned that
market interest rates will drop dramatically over the life of the bond?
a. Sinking fund
b. Deferred call
c. Freely callable
d. Non-callable
e. None of the above
ANS: C PTS: 1 OBJ: Multiple Choice

43. Which type of bond market is the largest sector in both Japan and the United States?
a. Corporate
b. High Yield/Emerging Market
c. Securitized/Collaterallized
d. Sovereign
e. Quasi & Foreign Governments
ANS: D PTS: 1 OBJ: Multiple Choice