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Question #1 of 43 Question ID: 1206317 The indenture of a callable bond states that the bond may be called on the rst business day of any month after the rst call date. The call option embedded in this bond is a(n): A) European style call option. B) American style call option. C) Bermuda style call option. Explanation A bond with a Bermuda style embedded call option may be called on prespeci ed dates after the rst call date. A European style embedded call option speci es a single date on which a bond may be called. With an American style embedded call option, a bond may be called any time after its rst call date. (Study Session 14, Module 42.2, LOS 42.f) Question #2 of 43 Question ID: 1206303 A bond has a par value of $5,000 and a coupon rate of 8.5% payable semi-annually. The bond is currently trading at 112.16. What is the dollar amount of the semi-annual coupon payment? A) $238.33. B) $212.50. C) $425.00. Explanation The dollar amount of the coupon payment is computed as follows: Coupon in $ = $5,000 × 0.085 / 2 = $212.50 (Study Session 14, Module 42.2, LOS 42.e) Question #3 of 43 Question ID: 1206288 Which of the following is least likely an example of external credit enhancement? A) Bank guarantee. B) Surety bond. C) Excess spread. Explanation Excess spread is an internal credit enhancement. External credit enhancements include bank guarantees, letters of credit, and surety bonds. (Study Session 14, Module 42.1, LOS 42.d)
Question #1 of 38 Question ID: 1206618 Bond X and Bond Y have the same par value, coupon, maturity, and credit rating, but Bond X trades at a higher price than Bond Y. A possible reason for this di erence is that: A) the market expects a downgrade to Bond Y’s credit rating. B) Bond Y has a higher expected recovery rate in a default. C) Bond X has a higher expected loss in a default. Explanation The market price di erence can be accounted for by a lag in the bonds' credit rating behind the market's assessment of their creditworthiness. The bond market may be expecting a downgrade of Bond Y or an upgrade of Bond X. Bond X would have a lower price than Bond Y if it had a higher expected loss. Bond Y would have a higher price than Bond X if it had a higher expected recovery rate. (Study Session 15, Module 47.1, LOS 47.e) Question #2 of 38 Question ID: 1206609 A non-callable bond with 18 years remaining maturity has an annual coupon of 7% and a $1,000 par value. The current yield to maturity on the bond is 8%. Using a 50bp change in YTM, the approximate modi ed duration of the bond is: A) 8.24. B) 11.89. C) 9.63. Explanation First, compute the current price of the bond as: FV = $1,000; PMT = $70; N = 18; I/Y = 8%; CPT → PV = –$906.28 Next, change the yield by plus-or-minus 50 basis points. Compute the price of the bond if rates rise by 50 basis points to 8.5% as: FV = $1,000; PMT = $70; N = 18; I/Y = 8.5%; CPT → PV = –$864.17 Then compute the price of the bond if rates fall by 50 basis points to 7.5% as: FV = $1,000; PMT = $70; N = 18; I/Y = 7.5%; CPT → PV = –$951.47 The formula for approximate modi ed duration is: (V- – V+) / (2V0ΔYTM) Therefore, approximate modi ed duration is: ($951.47 – $864.17) / (2 × $906.28 × 0.005) = 9.63. (Study Session 15, Module 47.1, LOS 47.c)
Question #3 of 38 Question ID: 1206626 Becque Ltd. is a European Union company with the following selected nancial information: € billions Year 1 Year 2 Year 3 Operating income 262 361 503 Depreciation & amortization 201 212 256 Capital expenditures 78 97 140 Cash ow from operations 303 466 361 Total debt 2,590 2,717 2,650 Dividends 70 70 72 Becque's three-year average debt-to-EBITDA ratio is closest to: A) 4.6x. B) 3.6x. C) 7.6x. Explanation EBITDA = Operating income + depreciation + amortization Year 1: 262 + 201 = €463 billion Year 2: 361 + 212 = €573 billion Year 3: 503 + 256 = €759 billion Debt/EBITDA ratio: Year 1: 2,590 / 463 = 5.6x Year 2: 2,717 / 573 = 4.7x Year 3: 2,650 / 759 = 3.5x Three-year average = 4.6x. (Study Session 15, Module 47.2, LOS 47.g) Question #4 of 38 Question ID: 1206623 The "four Cs" of credit analysis include: A) capacity and character. B) collateral and capital. C) circumstances and covenants. Explanation The "four Cs" of credit analysis are capacity, collateral, covenants, and character. (Study Session 15, Module 47.1, LOS 47.f)
Question #5 of 38 Question ID: 1206637 Support for revenue bonds comes from: A) property taxes based on the project. B) the full faith and credit of the issuing municipality. C) income generated by the underlying project. Explanation Revenue bonds are serviced by the income generated from speci c projects (e.g., toll roads). (Study Session 15, Module 47.2, LOS 47.j) Question #6 of 38 Question ID: 1206629 Which of the following is the most appropriate strategy for a xed income portfolio manager under the anticipation of an economic expansion? A) Sell corporate bonds and purchase Treasury bonds. B) Purchase corporate bonds and sell Treasury bonds. C) Sell lower-rated corporate bonds and buy higher-rated corporate bonds. Explanation During periods of economic expansion corporate yield spreads generally narrow, re ecting decreased credit risk. If yield spreads narrow, the prices of corporate bonds increase relative to the prices of Treasuries. Selling lower-rated bonds and buying higher-rated bonds is an appropriate strategy if an economic contraction is anticipated. (Study Session 15, Module 47.2, LOS 47.i) Question #7 of 38 Question ID: 1206605 The type of credit risk that is de ned as the possibility that a borrower will fail to pay interest or repay principal when due is: A) default risk. B) downgrade risk. C) credit spread risk. Explanation Default risk refers to the failure of a borrower to make timely and complete payments of interest or principal. (Study Session 15, Module 47.1, LOS 47.a)