SIE Products and Risks

Term Practice

In the event of a corporate liquidation, which security has the lowest priority of claim?

Common stock

Which class of stock normally has voting rights?

Common stock

Which class of stock normally receives dividends only after preferred dividends have been paid?

Common stock

A corporation has both common and preferred stock outstanding. If the company is liquidated, which stockholders are paid first?

Preferred stockholders

Which type of preferred stock accumulates omitted dividends?

Cumulative preferred stock

If a corporation skips preferred dividends for two years, which type of preferred stockholder must be paid those arrears before common shareholders can receive dividends?

Cumulative preferred stockholders

Which type of preferred stock is most likely to increase in value if the issuer's common stock rises sharply?

Convertible preferred stock

What feature allows a preferred shareholder to exchange preferred shares for common shares?

A conversion feature

Which type of preferred stock may receive additional distributions beyond its stated dividend?

Participating preferred stock

Which type of preferred stock may be redeemed by the issuer at a stated price?

Callable preferred stock

Which type of preferred stock exposes the investor to call risk?

Callable preferred stock

A customer wants equity ownership, voting rights, and the greatest upside potential. Which security best fits?

Common stock

A customer wants dividend preference over common stock and a prior claim in liquidation, but not creditor status. Which security best fits?

Preferred stock

Existing shareholders are granted the short-term privilege to buy additional shares below market price. What security is this?

Rights

Rights are generally issued at what relationship to the current market price?

Below market price

Rights are typically short-term or long-term?

Short-term

What is the main purpose of rights?

To allow existing shareholders to maintain proportional ownership

A company issues long-term certificates that allow holders to buy stock at a fixed price above the current market price. What are these?

Warrants

Warrants are generally issued at what relationship to the market price of the stock?

Above market price

Which generally last longer, rights or warrants?

Warrants

Which security is often attached to bonds or preferred stock as a sweetener?

Warrants

Which security is more likely to trade separately on an exchange for years

rights or warrants?

An investor wants exposure to a foreign company through U.S. markets and in U.S. dollars. Which product would most likely be used?

ADRs

What does ADR stand for?

American Depositary Receipt

Which product represents shares of a foreign company trading in U.S. markets?

ADRs

What is a corporate bond?

Debt issued by a corporation

What is a debenture?

An unsecured corporate bond backed only by the issuer's creditworthiness

Between a secured bond and a debenture of the same issuer, which has the greater claim on specific assets?

The secured bond

Which is generally riskier from the same issuer, a secured bond or a debenture?

A debenture

What is nominal yield?

The bond's stated coupon rate based on par value

What is current yield?

Annual interest divided by the bond's market price

Current yield measures what component of return?

Income only

Current yield ignores what two components?

Capital gains and capital losses

A bond pays $30 every six months. What annual interest is used to compute current yield?

$60

If interest rates rise, what generally happens to bond prices?

They fall

If interest rates fall, what generally happens to bond prices?

They rise

Which bonds have greater interest-rate risk, long-term bonds or short-term bonds?

Long-term bonds

Which type of bond is generally the most volatile

zero-coupon or current-income bonds of similar maturity?

What is a basis point?

0.01%

How many basis points equal 1%?

100 basis points

A bond is trading below par. What type of bond is it?

A discount bond

For a discount bond, place the yields in order from lowest to highest.

Nominal yield, current yield, yield to maturity, yield to call

On a discount bond, which is higher

nominal yield or yield to maturity?

On a discount bond, which yield is usually the highest?

Yield to call

Why does a discount bond investor gain as the bond approaches maturity?

The bond's price moves up toward par

A bond is trading above par. What type of bond is it?

A premium bond

For a premium bond, place the yields in order from highest to lowest.

Nominal yield, current yield, yield to maturity, yield to call

On a premium bond, which yield is usually the lowest?

Yield to call

Why does a premium bond investor lose premium over time?

The bond's price falls toward par at maturity

If a bond trades at par, how do nominal yield, current yield, YTM, and YTC compare?

They are all equal

An investor is evaluating a callable bond trading at a premium. Which yield is most important?

Yield to call

Why is yield to call the most important yield on a premium callable bond?

Because it is the lowest worst-case yield and the bond is likely to be called

Which Treasury security matures in one year or less?

Treasury bills

Which Treasury security matures in 2 to 10 years?

Treasury notes

Which Treasury security matures in more than 10 years?

Treasury bonds

Which Treasury securities are sold at a discount and mature at par with no periodic interest payments?

Treasury bills

Which Treasury security is specifically designed to protect against purchasing-power risk?

TIPS

How do TIPS protect against inflation?

Their principal is adjusted based on changes in the CPI

Which Treasury security is created by separating the principal and interest payments of Treasury securities?

STRIPS

Do STRIPS make periodic interest payments?

No

Which Treasury security is most directly exposed to purchasing-power risk if inflation rises sharply

TIPS or Treasury notes?

A customer wants a U.S. government security with inflation-adjusted principal. Which security is most suitable?

TIPS

A customer wants a short-term government instrument maturing in less than one year. Which security is most suitable?

Treasury bills

Which agency security is backed by the full faith and credit of the U.S. government

GNMA or FNMA?

Which is more directly backed by the U.S. government, GNMA or FHLMC?

GNMA

What does GNMA stand for?

Government National Mortgage Association

What does FNMA stand for?

Federal National Mortgage Association

What does FHLMC stand for?

Federal Home Loan Mortgage Corporation

Which agency-related securities are commonly associated with mortgage-backed securities?

GNMA, FNMA, and FHLMC securities

Which mortgage-backed security type exposes investors to prepayment risk?

Agency mortgage-backed securities

When interest rates fall, what risk tends to increase for mortgage-backed securities?

Prepayment risk

Why is prepayment risk a concern for mortgage-backed securities?

Borrowers may refinance early, returning principal when rates are lower

What is a municipal bond?

Debt issued by a state or local government

Which municipal bond is backed by the issuer's full faith, credit, and taxing power?

A general obligation bond

Which municipal bond is backed by revenues from a specific project or facility?

A revenue bond

Which type of municipal bond permits the issuer to raise property taxes to help meet debt service?

A general obligation bond

Which municipal bond is more dependent on the success of a project, a GO bond or a revenue bond?

A revenue bond

Interest from most municipal bonds is generally exempt from what tax?

Federal income tax

What formula is used to compare a tax-free municipal bond to a taxable bond?

Tax-equivalent yield

What is the tax-equivalent yield formula?

Municipal yield divided by 1 minus the tax rate

A customer in a high tax bracket is comparing a municipal bond with a corporate bond. Which yield calculation is most useful?

Tax-equivalent yield

Which municipal bond would more likely finance a toll road, airport, or stadium?

A revenue bond

Which municipal bond is generally considered safer when comparing taxing power versus project revenues?

A general obligation bond

What is a money market instrument?

A short-term debt instrument maturing in one year or less

Which money market instrument is an unsecured short-term promissory note issued by a corporation?

Commercial paper

Which money market instrument is commonly used to finance importing and exporting operations?

Banker's acceptances

Which money market instrument represents dollar-denominated deposits in banks outside the United States?

Eurodollar CDs

Which instrument is a short-term U.S. government obligation

Treasury bill or banker's acceptance?

Which money market instrument is backed by a bank's guarantee and used in foreign trade?

A banker's acceptance

Which money market instrument is issued by corporations rather than by the U.S. government?

Commercial paper

A customer wants a short-term instrument used in trade finance. Which product best fits?

A banker's acceptance

A customer wants a short-term negotiable bank deposit with a stated rate. Which product best fits?

A certificate of deposit

What is a mutual fund?

An open-end investment company that continuously issues redeemable shares

At what price are mutual fund shares purchased and redeemed?

Net asset value, or NAV

What is the NAV formula?

Assets minus liabilities divided by shares outstanding

When is mutual fund NAV calculated?

Once per day at market close

What does forward pricing mean in mutual funds?

Orders entered during the day receive the next calculated NAV

What is the sales charge formula?

POP minus NAV divided by POP

In the sales charge formula, what goes in the denominator?

POP

A mutual fund's sales charge is expressed as a percentage of what?

The public offering price