Reading 39 Fixed-Income Securities: Defining Elements
PRACTICE PROBLEMS
1
A 10-year bond was issued four years ago. The bond is denominated in US dollars, offers a coupon rate of 10% with interest paid mi-annually, and is currently priced at 102% of par. The bond’s:
A tenor is six years.
B nominal rate is 5%.
C redemption value is 102% of the par value.
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A is correct. The tenor of the bond is the time remaining until the bond’s matu rity date. Although the bond had a maturity of ten years at issuance (original maturity), it was issued four years ago. Thus, there are six years remaining until the maturity date.
B is incorrect becau the nominal rate is the coupon rate (i.e., the interest rate that the issuer agrees to pay each year until the maturity date). Although interest is paid mi-annually, the nominal rate is 10%, not 5%.
C is incorrect becau it is the bond’s price, not its redemption value (also called principal amount, principal value, par value, face value, nominal value, or maturity value), that is equal to 102% of the par value.
2
A sovereign bond has a maturity of 15 years. The bond is best described as a:
A perpetual bond.
B pure discount bond.
C capital market curity.
SOLUTIONS
你给我滚C is correct. A capital market curity has an original maturity longer than one year.
A is incorrect becau a perpetual bond does not have a stated maturity date. Thus, the sovereign bond, which has a maturity of 15 years, cannot be a perpetual bond.
B is incorrect becau a pure discount bond is a bond issued at a discount to par value and redeemed at par. Some sovereign bonds (e.g., Treasury bills) are pure discount bonds, but others are not.
3
A company has issued a floating-rate note with a coupon rate equal to the three-month MRR + 65 bps. Interest payments are made quarterly on 31 March, 30 June, 30 September, and 31 December. On 31 March and 30 June, the three-month MRR is 1.55% and 1.35%, respectively. The coupon rate for the interest payment made on 30 June is:
A 2.00%.
B 2.10%.
C 2.20%.
SOLUTIONS
C is correct. The coupon rate that applies to the interest payment due on 30 June is bad on the three-month MRR rate prevailing on 31 March. Thus, the coupon rate is 1.55% + 0.65% = 2.20%.
4
The legal contract that describes the form of the bond, the obligations of the issuer, and the rights of the bondholders can be best described as a bond’s:
图卢兹二大A covenant.
B indenture.
C debenture.
SOLUTIONS
B is correct. The indenture, also referred to as trust deed, is the legal contract that describes the form of the bond, the obligations of the issuer, and the rights of the bondholders.
A is incorrect becau covenants are only one element of a bond’s indenture. Covenants are clau
s that specify the rights of the bondholders and any actions that the issuer is obligated to perform or prohibited from performing. C is incorrect becau a debenture is a type of bond.
5
Which of the following is a type of external credit enhancement?
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A Covenants
B A surety bond
C Overcollateralization
SOLUTIONS
B is correct. A surety bond is an external credit enhancement (i.e., a guarantee received from a third party). If the issuer defaults, the guarantor who provided the surety bond will reimbur investors for any loss, usually up to a maximum amount called the penal sum.
A is incorrect becau covenants are legally enforceable rules that borrowers and lenders agree upo
n when the bond is issued. C is incorrect becau overcollateralization is an internal, not external, credit enhancement. Collateral is a guarantee underlying the debt above and beyond the issuer’s promi to pay, and overcollateralization refers to the process of posting more collateral than is needed to obtain or cure financing. Collateral, such as asts or curities pledged to ensure debt payments, is not provided by a third party. Thus, overcollateralization is not an external credit enhancement.
6
An affirmative covenant is most likely to stipulate:
A limits on the issuer’s leverage ratio.
B how the proceeds of the bond issue will be ud.
C the maximum percentage of the issuer’s gross asts that can be sold.
SOLUTIONS
B is correct. Affirmative (or positive) covenants enumerate what issuers are required to do and are ty
pically administrative in nature. A common affirmative covenant describes what the issuer intends to do with the proceeds from the bond issue.
A and C are incorrect becau imposing a limit on the issuer’s leverage ratio or on the percentage of the issuer’s gross asts that can be sold are negative covenants. Nega tive covenants prevent the issuer from taking actions that could reduce its ability to make interest payments and repay the principal.
7
Which of the following best describes a negative bond covenant? The issuer is:
A required to pay taxes as they come due.
B prohibited from investing in risky projects.
C required to maintain its current lines of business.香菇木耳炖鸡
SOLUTIONS
B is correct. Prohibiting the issuer from investing in risky projects restricts the issuer’s potential business decisions. The restrictions are referred to as negative bond covenants.
A and C are incorrect becau paying taxes as they come due and maintaining the current lines of business are positive covenants.
8
腿的英语单词A South African company issues bonds denominated in pound sterling that are sold to investors in the United Kingdom. The bonds can be best described as:
A Eurobonds.
B global bonds.
C foreign bonds.
SOLUTIONS
C is correct. Bonds sold in a country and denominated in that country’s cur rency by an entity from another country are referred to as foreign bonds.
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A is incorrect becau Eurobonds are bonds issued outside the jurisdiction of any single country.
B is incorrect becau global bonds are bonds issued in the Eurobond market and at least one domestic country simultaneously.
9
Relative to domestic and foreign bonds, Eurobonds are most likely to be:
A bearer bonds.
B registered bonds.
C subject to greater regulation.
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SOLUTIONS
A is correct. Eurobonds are typically issued as bearer bonds (i.e., bonds for which the trustee does not keep records of ownership). In contrast, domestic and foreign bonds are typically registered bonds for which ownership is recorded by either name or rial number.
B is incorrect becau Eurobonds are typically issued as bearer bonds, not registered bonds.
C is incorrect becau Eurobonds are typically subject to lower, not greater, regulation than domestic and foreign bonds
10
An investor in a country with an original issue discount tax provision purchas a 20-year zero-coupon bond at a deep discount to par value. The investor plans to hold the bond until the maturity date. The investor will most likely report:
A a capital gain at maturity.
B a tax deduction in the year the bond is purchad.
C taxable income from the bond every year until maturity.
SOLUTIONS
C is correct. The original issue discount tax provision requires the investor to include a prorated porti
on of the original issue discount in his taxable income every tax year until maturity. The original issue discount is equal to the difference between the bond’s par value and its original issue price.
A is incorrect becau the original issue discount tax provision allows the investor to increa his cost basis in the bond so that when the bond matures, he faces no capital gain or loss.
B is incorrect becau the original issue discount tax provision does not require any tax deduction in the year the bond is purchad or afterwards.
-------------------笔记From Fixed-income Reading39，P435-----------------
Bond interest is usually taxed at the ordinary income tax rate, which is typically the same tax rate that an individual would pay on wage or salary income. Tax-exempt curities are the exception to this rule.
In addition to earnings from interest, a bond investment will generate a capital gain or loss. Capital gains or loss usually face different tax treatment from taxable income, which often varies for long-term and short-term capital gains.
