978-0134083308 Chapter 10 Part 3

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3) In an inflationary environment, the interest payments on Treasury inflation-indexed

obligations increase over time.

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4) If the inflation rate is 2%, the principal of a Treasury inflation protection security will from

$1,000 to $1,020.

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5) If you hold a zero-coupon bond to maturity, the fully compounded rate of return is virtually

guaranteed to be equal to the rate stated at the time the bond was purchased.

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6) Zero coupon bonds have very limited price volatility.

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7) Municipal bonds are most attractive to residents of states with high income tax rates.

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8) Mortgage-backed bonds are issued primarily by state governments and are secured by home

mortgages.

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9) Securitization is the process of creating marketable securities from various types of loans.

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10) Collateralized mortgage obligations are relatively low risk investments.

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11) Junk bond appeal to some investors because of higher yields and potentially higher capital

gains than those offered by investment grade bonds.

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12) The various CMO tranches can have significantly different degrees of prepayment risk.

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13) CMO tranches are structured to create long, intermediate and short-term securities.

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14) Which one of the following statements concerning Treasury bonds is correct?

A) The par values of all Treasury bonds are adjusted periodically in response to changes in the

rate of inflation.

B) Treasury bonds have maturity dates ranging from two to ten years.

C) Interest earned on Treasury bonds is tax-exempt at the federal level.

D) All Treasury securities are backed by the “full faith and credit” of the U.S. government.

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15) Which of the following statements about U.S. Agency bonds are true?

I. They are backed by the “full faith and credit” of the U.S. government.

II. Their risk is almost as low as government notes and bonds.

III. Their yields are slightly higher than those of government securities.

IV. They are exempt from state and federal taxes.

A) I, II and IV only

B) I, III and IV only

C) II and III only

D) I and IV only

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16) Debt securities issued by the Federal Home Loan Bank, the Student Loan Marketing

Association and the Government National Mortgage Association are known as

A) agency bonds.

B) organizational bonds.

C) municipal bonds.

D) Treasury bonds.

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17) Which of the following statements concerning mortgage backed securities are correct?

I. They are secured by a pool of residential mortgages.

II. A portion of the income stream is a non-taxable return of capital.

III. They are backed by the full faith and credit of the U.S. government.

IV. Their maturity depends on prepayments of the mortgages in the pool.

A) I and III only

B) I and IV only

C) II, III and IV only

D) I, II and IV only

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18) Municipal bonds can be either general obligation bonds or revenue bonds. Of these two

types of municipal bonds, only general obligation bonds

A) are specifically serviced by the income generated from particular projects.

B) are backed by the full faith and credit of the issuer.

C) repay the principal only if a sufficient level of revenue is generated.

D) have the principal and interest guaranteed by a third party.

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19) Which of the following statements are correct concerning municipal bonds?

I. Yields on municipal bonds are usually lower than yields on Treasury bonds.

II. Municipal bonds are most appealing to individuals with high incomes.

III. Interest on a municipal bond is exempt from federal income tax.

IV. Municipal bonds are less risky than Treasury bonds.

A) I, II, III and IV

B) I, II and III only

C) II, III and IV only

D) II and III only

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20) Kayla is in the 28% federal income tax bracket and the 5% state income tax bracket. If she

purchases a municipal bond yielding 4.25%, what is the equivalent yield on a taxable bond if

the municipal bond income is exempt from both federal and state taxes?

A) 4.47%

B) 5.90%

C) 6.34%

D) 6.21%

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21) What is the tax-equivalent yield of a double tax-free 4% municipal bond if the investor is in

the 33% federal and 6% state tax brackets?

A) 6.35%

B) 5.97%

C) 6.56%

D) 4.26%

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22) Which one of the following statements concerning the tax treatment of municipal bonds is

correct?

A) The interest income on municipal bonds is subject to federal income tax.

B) The capital gain realized on the sale of a municipal bond is tax-free income.

C) Interest income on a municipal bond is usually exempt from state and local income taxes if

the bond is issued by the state or locality in which the investor resides.

D) Municipal bonds receive no special income tax treatment.

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23) Martin is trying to decide which one of the following bonds he should purchase. All the

bonds have the same maturity date and all have approximately the same level of risk. The

general level of interest rates is declining. Martin is in the 33 percent federal income tax bracket

and the 6 percent state income tax bracket. The municipal bonds are from his home state.

Which bond should Martin purchase if he wishes to hold it for the long term?

A) bond A because it has the highest yield and is unlikely to be called when rates are declining

B) bond B because it has the highest after tax yield and is unlikely to be called when rates are

declining

C) bond C because bond D is likely to be called

D) bond D because it has the highest after tax yield and is unlikely to be called when rates are

declining

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24) The denomination of most corporate bonds is ________ and the maturities generally range

from ________.

A) $1,000; 5 to 10 years

B) $1,000; 20 to 30 years

C) $100,000; 5 to 10 years

D) $100,000; 25 to 40 years

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25) Which of the following statements concerning equipment trust certificates are correct?

I. Equipment trust certificates are typically used to raise funds for purchasing airplanes and

railroad engines.

II. Equipment trust certificates are usually issued with a single maturity date.

III. Equipment trust certificates normally mature in 20 to 30 years.

IV. Equipment trust certificates generally offer above-average yields.

A) I and IV only

B) II and IV only

C) I and III only

D) I, III and IV only

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26) Which one of the following statements correctly describes the unique feature of GNMA

pass-through securities?

A) The interest income on a GNMA is exempt from state and federal tax.

B) GNMAs consistently have lives of 25-30 years.

C) GNMAs are backed by the full faith and credit of the issuing state.

D) GNMAs pay income to holders on a monthly basis.

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27) Which one of the following statements correctly describes the major drawback of a zero-

coupon bond?

A) Unless the bond is held in a tax-sheltered account, the investor must pay taxes on the annual

accrued interest even though no interest is actually received.

B) The conversion feature found on most zero-coupon bonds generally requires the investor to

switch to a coupon-bearing bond after a period of 5 years.

C) The lack of an annual coupon basically prohibits the investor from locking in a high rate of

return.

D) Because there is no reinvestment of a coupon payment, large capital losses accrue when

interest rates decline.

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28) Which of the following characteristics apply to collateralized mortgage obligations?

I. All bondholders receive a pro-rata share of all interest payments.

II. CMOs are derivative securities created from mortgage-backed bonds.

III. All principal payments are paid to the shortest remaining tranche.

IV. CMOs have definite maturity dates for each tranche.

A) I and II only

B) I and III only

C) I, II and III only

D) II, III and IV only

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29) The practice of bundling mortgages or other types of loans into pools and selling pieces of

the pool as bond-like instruments to investors is known as

A) securitization.

B) privatization.

C) collateralization.

D) fractionalization.

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30) Asset backed securities (ABS)are relatively safe investments because

A) they are collateralized only with the highest quality loans.

B) because the debt pools are highly diversified.

C) because the pool of assets backing the securities is often much larger than the bond issue.

D) because the loans in the pool are collateralized with valuable assets such as cars and trucks.

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31) Pass-through securities backed by pools of auto loans, credit card bills, and computer leases

are known as

A) PIK bonds.

B) REIMCs.

C) ABSs.

D) Fannie Maes.

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32) Securitization is the practice of

A) bundling loans into large pools and dividing them into bond-like securities.

B) selling government debt in the private sector.

C) increasing the safety of asset backed securities by insuring them.

D) protecting the privacy of borrowers whose loans have been sold to a third party.

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