Chapter 2

Basis Points- Basis points (bps) are a unit of measurement used to discuss changes in interest rates. Each basis point equals one-hundredth of a percentage point and therefore 100 bps is the equivalent of 1%.

Serial Bonds- In a serial bond issue, the outstanding bonds mature at different intervals with a portion of the issue maturing each year. Example: A 20-year bond with a 10-year call protection period could be called any time after year 10 through maturity.

Credit RatingsBond rating services publish credit ratings to inform investors of a bond’s credit quality. A bond's credit rating may change periodically while it is outstanding. Credit ratings are typically a significant factor in the liquidity of bonds (even more so than the coupon or maturity).

Adjusting Premium Bonds by AmortizationBonds purchased at a premium (> $1,000 par) must be amortized over the life of the bond.

Amortization means that the cost basis will be adjusted downwards each year so that at maturity an investor’s cost basis is $1,000 par. What will amortization affect? Amortization affects a bond’s cost basis (downwards) and should the investor sell the bond prior to maturity, the profit or loss on the transaction. Amortization does not affect sale proceeds (what a purchaser is willing to pay). Example: When an investor purchases a bond at a premium, the cost basis will be adjusted downward towards par on a straight-line basis. This is referred to as amortization. For example, a 10-year bond bought at 110 would be adjusted by one point per year, calculated as: 10-point premium /10 years to maturity = 1 point per year.

Dated Date- The dated date is the date when interest begins to accrue on fixed income securities. The dated date is only relevant for new issuances and once regular semi-annual coupon payments begin, it is no longer relevant.

Refunding-The process of calling a bond when interest rates have fallen and issuing a new bond with a lower coupon rate is called refunding.

EMMA Website- The Electronic Municipal Market Access (EMMA) website provides updated information about the issuer, the municipal bond, and its credit rating.

Bond quotations- Bonds are quoted as a percentage of par. It is important to note that bond quotes can also include fractions, such as 1/8ths (Corporate& Municipal bonds) or 1/32nds (Government bonds) of a point. These fractions are used to represent smaller price increments.

: What happens when a bond’s credit rating is upgraded?
A:
I. Its price will increase
IV. Its yield will decrease
✅ Explanation: A higher credit rating makes the bond more attractive, increasing demand and price. Due to the inverse relationship, yield falls.

Flashcard 2

Q: What is true about bond redemption if it is called prior to maturity?
A:
I. The investor may receive a call premium
III. The investor receives final interest upon redemption
✅ Explanation: A call premium is possible but not guaranteed. Accrued interest since the last payment is received by the investor.

Flashcard 3

Q: A municipal bond is purchased on Friday, September 1, with regular way settlement. The bond pays interest on June 1 and December 1. How many days of accrued interest are added to the price?
A: 93 days
✅ Explanation: Based on 30-day months and T+1 settlement, accrued interest includes June (30), July (30), August (30), and 3 days of September (up to but not including Sept. 4).

Flashcard 4

Q: An investor sells 10 XYZ April 20 Puts when XYZ is trading at $25. If XYZ stays above $20 through expiration, what happens?
A: The options expire worthless, and the investor retains the premium.
✅ Explanation: The puts are out-of-the-money, so they expire and the seller keeps the premium.

Flashcard 5

Q: A Town of X bond has a YTM of 2.50% and a yield to call of 2.75%. How is it priced?
A: Below par value
✅ Explanation: A bond trades at a discount when its yield to call is higher than its yield to maturity.

Flashcard 6

Q: Which of the following statements about bond maturity is NOT true?
A: Long-term bonds generally provide greater liquidity than short-term bonds
✅ Explanation: Long-term bonds usually have less liquidity and are more sensitive to interest rate changes, unlike short-term bonds.

Premium- When a bond trades above par value (e.g., $1,050 for a $1,000 bond)

• Occurs when interest rates fall below the bond's coupon rate

Discount- When a bond trades below par value (e.g., $950)

• Occurs when interest rates rise above the bond's coupon rate

At Premium:
NY > CY > YTM > YTC
→ Because the investor paid more upfront, total return is lower.

At Discount:
NY < CY < YTM < YTC
→ Because the investor paid less, total return is higher.

What happens when the bond price goes down- it is trading at a discount, and the current yield goes up as a result

Q: Which maturity bond from the same issuer usually pays the highest yield?
A: D. 30-year maturity
✅ Explanation: Longer maturities carry more uncertainty and interest rate risk, so they typically offer higher yields.

Flashcard 2

Q: What determines the interest paid by a floating-rate bond?
A: C. The value of a widely accepted bond benchmark
✅ Explanation: Floating rates are tied to indices like Treasury bills plus a spread.

Flashcard 3

Q: John bought an 8% XYZ bond for $900, now worth $980. What is the current yield?
A: B. 8.2%
✅ Explanation: $80 / $980 = 8.2% (current yield = annual interest ÷ current price).

Flashcard 4

Q: What type of bond allows early redemption by the issuer with a premium?
A: A. Callable
✅ Explanation: Callable bonds can be redeemed before maturity, often with a call premium.

Flashcard 5

Q: When is an issuer most likely to call a bond?
A: D. When interest rates are falling
✅ Explanation: Issuers refinance debt at lower rates when market rates decline.

Flashcard 6

Q: Who has the right to demand early redemption in a puttable bond?
A: A. Only the investor
✅ Explanation: A put feature gives the investor the right to redeem early, often used when rates rise.

Flashcard 7

Q: What does a sinking fund do for bondholders?
A: D. Ensures funding to retire bonds at maturity
✅ Explanation: A sinking fund sets aside money over time to pay back bondholders.

Flashcard 8

Q: Which yield stays the same throughout the bond’s life?
A: A. Nominal yield
✅ Explanation: Nominal yield is fixed at issuance, based on par and coupon.

Flashcard 9

Q: What happens to a bond’s current yield if market price drops?
A: A. It will increase
✅ Explanation: Lower price = higher yield (current yield = interest ÷ price).

Flashcard 10

Q: A bond has a current yield of 4.5% and a nominal yield of 4.7%. What kind of bond is it?
A: B. Premium
✅ Explanation: Current yield < nominal yield = bond is priced above par.

Flashcard 11

Q: Which call date is used in yield-to-call (YTC) calculations?
A: A. The first
✅ Explanation: YTC assumes the bond will be called at the earliest call date.

Flashcard 12

Q: For a bond trading at a discount, which yield is the lowest?
A: A. Nominal yield
✅ Explanation: Nominal yield doesn’t include price appreciation at maturity.

Flashcard 13

Q: For zero-coupon bonds, which yield is most meaningful?
A: B. Yield to maturity
✅ Explanation: Zeros don’t pay current interest, so YTM is the only relevant yield.

Flashcard 14

Q: Which bond gains the most in value when interest rates fall?
A: C. 30-year, zero-coupon bond
✅ Explanation: Long-term, low-coupon bonds are most sensitive to rate changes.

Flashcard 15

Q: Which bond type is free from reinvestment risk?
A: D. Zero-coupon
✅ Explanation: No coupon payments = no reinvestment risk.

Flashcard 16

Q: What is the lowest S&P rating considered investment-grade?
A: A. BBB
✅ Explanation: BBB (S&P) or Baa (Moody’s) is the lowest investment-grade rating.

Arthur buys zero-coupon bonds for his grandchild’s college fund. Which of the following yields will be most meaningful for his bonds?

A. Nominal yield

B. Yield to maturity

C. Current yield

D. All yields are equally meaningful

Which of the following bonds will appreciate the most as interest rates fall?

A. 10-year, zero-coupon bond

B. 10-year, 5% bond

C. 30-year, zero-coupon bond

D. 30-year, 5% bond

Which of the following measures of bond yield does not change over the full life of the bond?

A. Nominal yield- Nominal yield is set at the time a bond is issued and does not change. The calculation uses par value, a constant, as the denominator. The numerator is annual interest payable, also a constant

B. Current yield

C. Yield to maturity

D. Yield to call