Questions 1 through 19 are related. An issue of 8.5% Series C preferred stock has a par value of $75 million or $40 per share and was sold to investors several years ago at par. According to the terms...

Questions 1 through 19 are related.

An issue of 8.5% Series C preferred stock has a par value of $75 million or $40 per share and was sold to investors several years ago at par. According to the terms of the issue, the preferred is scheduled to be redeemed in 25 years at its par value of $40 per share. Dividends are paid quarterly but analyzed as if paid annually. The stock is currently trading at a discount for $35 per share.

1. Which of the factors listed below could have contributed to the stock trading at $35 per share instead of the par value of $40?

1. 
   Interest rates have increased since the preferred was issued.
   


2. 
   Interest rates have decreased since the preferred was issued.
   


3. 
   The issuer’s debt/equity ratio has decreased significantly since the preferred was issued.
   


4. 
   The issuer’s net income and free cash flow have increased significantly since the preferred was issued.
   


5. 
   Answers a, c, and d are correct.
   

2. As a prospective investor in this preferred, what is the expected rate of return to redemption in 25 years? Assume dividends are paid annually and it is exactly 1 year to the next dividend.

1. 
   4.93%
   


2. 
   5.05%
   


3. 
   8.50%
   


4. 
   9.86%
   


5. 
   10.11%
   

3. Using Macaulay’s Duration [but on an annual basis rather than semi-annual because m = 1], the Duration of the Preferred Stock is:

1. 
   4.9 years
   


2. 
   5.2 years
   


3. 
   9.8 years
   


4. 
   10.3 years
   


5. 
   14.7 years
   

4. Using the convexity formula given on the last page of the exam, [but on an annual basis rather than semi-annual because m = 1], the Convexity of the Preferred Stock is:

1. 
   81.2
   


2. 
   148.1
   


3. 
   162.7
   


4. 
   1162.3
   


5. 
   178.7
   

5. Suppose now the redeemable preferred has a redemption schedule requiring redemption of 1/15 of the original issue, or $5 million, at the end of years 11 through 25. It also specifies that the Trustee must randomly select the shares to be redeemed in each year. What is the expected term to redemption and rate of return with this redemption schedule?

1. 
   17 Years and 4.93%
   


2. 
   17 Years and 8.50%
   


3. 
   18 Years and 9.86%
   


4. 
   18 Years and 10.03%
   


5. 
   19 Years and 10.11%
   

6. The Duration of the Preferred Stock with the data given in question #5 [on an annual basis with m = 1], is now:

1. 
   4.2 years
   


2. 
   4.4 years
   


3. 
   4.6 years
   


4. 
   8.9 years
   


5. 
   9.3 years
   

7. The Convexity of the Preferred Stock with the data given in question #5 [on an annual basis with m = 1], is now:

1. 
   66.8
   


2. 
   110.4
   


3. 
   121.2
   


4. 
   121.5
   


5. 
   133.7
   

8. Assume now the redeemable preferred has a redemption schedule requiring redemption of redemption of $5 million of preferred shares at the end of years 16 through 24 and the balance of $30 million in year 25. What is the expected term to redemption and rate of return with this redemption schedule?

1. 
   21 years and 4.93%
   


2. 
   21 years and 9.86%
   


3. 
   22 years and 8.50%
   


4. 
   22 years and 9.92%
   


5. 
   23 years and 9.86%
   

9. The Duration of the Preferred Stock with the data given in question #8 [on an annual basis with m = 1], is:

1. 
   5.0 years
   


2. 
   9.1 years
   


3. 
   9.5 years
   


4. 
   10.0 years
   


5. 
   10.4 years
   

10. The Convexity of the Preferred Stock with the data given in question #8 [on an annual basis with m = 1], is:

1. 
   73.2
   


2. 
   133.5
   


3. 
   146.4
   


4. 
   146.7
   


5. 
   161.3
   

11. As an alternative to having the Trustee randomly select the shares to be redeemed, suppose the issuer is permitted to purchase preferred shares on the open market in order to fulfill its obligation to redeem shares. Specifically, the company can buy the shares at the market price and present them for cancellation rather than pay the Trustee $40 per share for the shares to be redeemed. Which of the following statements is most correct?

1. 
   The issuer would exercise this Delivery Option when the price is less than $40.
   


2. 
   The issuer would exercise this Delivery Option when the price is greater than $40.
   


3. 
   The issuer would exercise this Acceleration Option when the price is less than $40.
   


4. 
   The issuer would exercise this Acceleration Option when the price is greater than $40.
   


5. 
   The issuer would most likely never exercise this Delivery Option unless the price is less than $25.
   

12. Assume the year 16 redemption is only one week away and the issuer has not purchased any shares in the open market. What factors might cause the circumstance described in question #11 to occur?

1. 
   Interest rates have increased since the preferred was issued.
   


2. 
   Interest rates have decreased since the preferred was issued.
   


3. 
   The shares are held by a small number of institutional investors.
   


4. 
   Both answers a. and c. could be a cause.
   


5. 
   None of the above factors could be a cause.
   

13. If the issuer buys shares in the market and is able to submit them to the Trustee at the next redemption is lieu of cash, what effect this will have on the expected rate of return for investors?

1. 
   The expected rate of return will be reduced.
   


2. 
   The expected rate of return will be increased.
   


3. 
   The expected rate of return will be unchanged.
   


4. 
   All of the above answers are correct.
   


5. 
   None of the above answers are correct.
   

14. Assume time has passed and it is now the beginning of year 15 [year 14 obligations have just been paid]. The preferred trades for $42. Using the Redemption schedule from question #5, [the redemption schedule requiring redemption of 1/15 of the original issue, or $5 million, at the end of years 11 through 25] what is the expected rate of return on the shares. Assume the issuer has met the redemption obligations for years 11 through 14 and the issuer does not hold any shares purchased in the open market. Shares to be redeemed in future years will be randomly selected.

1. 
   7.44%
   


2. 
   8.03%
   


3. 
   8.50%
   


4. 
   9.86%
   


5. 
   14.87%
   

15. The Duration of the Preferred Stock with the data given in question #14 [on an annual basis with m = 1], is:

1. 
   2.4 years
   


2. 
   2.5 years
   


3. 
   4.6 years
   


4. 
   4.8 years
   


5. 
   5.0 years
   

16. The Convexity of the Preferred Stock with the data given in question #14 [on an annual basis with m = 1], is:

1. 
   15.1
   


2. 
   28.1
   


3. 
   30.2
   


4. 
   32.5
   


5. 
   34.7
   

17. Assume time has passed and it is now the beginning of year 15 [year 14 dividends have just been paid]. The preferred trades for $42. Using the Redemption schedule from question #8, [the redemption schedule requires redemption of $5 million of preferred shares at the end of years 16 through 24 and the balance of $30 million in year 25] what is the best estimate of the expected rate of return on the shares. Assume the issuer does not hold any shares purchased in the open market. Shares to be redeemed in future years will be randomly selected.

1. 
   7.64%
   


2. 
   8.03%
   


3. 
   8.50%
   


4. 
   10.03%
   


5. 
   15.28%
   

18. The Duration of the Preferred Stock with the data given in question #17 [on an annual basis with m = 1], is:

1. 
   3.0 years
   


2. 
   5.7 years
   


3. 
   5.9 years
   


4. 
   6.0 years
   


5. 
   6.2 years
   

19. The Convexity of the Preferred Stock with the data given in question #17 [on an annual basis with m = 1], is:

1. 
   23.4
   


2. 
   43.5
   


3. 
   46.8
   


4. 
   50.4
   


5. 
   56.4
   

Questions 20 through 22 are related.

20. The 10.80% debentures of Toxic Chemical Corp. mature on December 1, 2031 and currently trade at 109.1. Interest is paid semi-annually and December 1 is a coupon anniversary date. [Assume today is December 1, 2020 so term to maturity is 11 years.] The debentures have a sinking fund requiring redemption of the debentures according to the schedule shown below. Selection of bonds to be redeemed is done by random draw, or lottery. Assume the issuer does not currently hold any bonds and will not acquire bonds other than to satisfy sinking fund requirements.

Years 1 - 6 7 8 9 10 11

Sinking Fund None 20% 20% 20% 20% 20%

What is the yield to expected term of the debentures?

1. 
   4.12%
   


2. 
   4.64%
   


3. 
   7.73%
   


4. 
   9.29%
   


5. 
   9.45%
   

21. Using Macaulay’s Duration with coupons paid semi-annually, the Duration of the debentures is:

1. 
   5.8 years
   


2. 
   6.0 years
   


3. 
   6.1 years
   


4. 
   12.0 years
   


5. 
   12.2 years
   

22. With coupons paid semi-annually, the Convexity of the debentures is:

1. 
   23.1
   


2. 
   40.5
   


3. 
   44.2
   


4. 
   48.4
   


5. 
   52.9
   

Questions 23 through 28 are related.

23. You are a credit analyst in the asset management department of a large bank or insurance company. The credit department is researching an investment in a syndicated loan to a large firm that used the funds to open a chain of karate dojos. The loan is an “amortized loan” with a 9% interest rate payable semi-annually. The original term was 10 years but the loan has been outstanding for 2 years so there are 8 years to maturity. Payments on the loan are up to date and the fourth payment has just been made so the next payment is due in 6 months. With syndicated loans, the redemptions are usually not randomly selected, but are paid down proportionately. The loan is currently trading at 87 on the remaining balance of the loan. For analytical purposes, assume the loan trades in $1000 increments. What are the semi-annual payments on the loan?

1. 
   $76.88
   


2. 
   $79.35
   


3. 
   $89.02
   


4. 
   $100.00
   


5. 
   $190.00
   

24. The amortized loan had an original term of 10 years but 2 years have passed. What is the outstanding balance on the loan with 8 years to maturity?

1. 
   $787.59
   


2. 
   $800.00
   


3. 
   $850.99
   


4. 
   $863.63
   


5. 
   $870.02
   

25. The loan currently trades at 87% of the remaining loan balance. What would the loan trade at in dollar terms?

1. 
   $756.92
   


2. 
   $751.36
   


3. 
   $740.36
   


4. 
   $696.00
   


5. 
   $685.20
   

26. What is the yield to maturity on the loan?

1. 
   7.23%
   


2. 
   7.44%
   


3. 
   8.06%
   


4. 
   12.98%
   


5. 
   14.87%
   

27. With cash flows paid semi-annually, the Duration of the loan is:

1. 
   3.4 years
   


2. 
   3.6 years
   


3. 
   3.8 years
   


4. 
   6.8 years
   


5. 
   7.2 years
   

28. With cash flows paid semi-annually, the Convexity of the loan is:

1. 
   10.1
   


2. 
   16.8
   


3. 
   19.0
   


4. 
   21.6
   


5. 
   27.4
   

Questions 29 through 37 are related.

29. An issue of 9.60% senior debentures matures on December 15, 2029 and currently trade at 104.65 Interest is paid semi-annually and December 15 is a coupon anniversary date. [Assume today is December 15, 2020 so term to maturity is 9 years.] The debentures are callable on or at any time thereafter on the dates shown on the schedule below for the prices shown on the schedule. First call is 4 years away. What is the Yield to Maturity of the bonds?

December 15, 2020-2023 2024 2025 2026 2027 2028

Call Price No Call 104% 103% 102% 101% 100.5%

1. 
   8.21%
   


2. 
   8.35%
   


3. 
   8.84%
   


4. 
   9.04%
   


5. 
   9.13%
   

30. The Duration of the bonds if held to maturity is:

1. 
   5.5 years
   


2. 
   6.0 years
   


3. 
   6.3 years
   


4. 
   6.6 years
   


5. 
   11.6 years
   

31. The Convexity of the bonds if held to maturity is:

1. 
   26.5
   


2. 
   46.7
   


3. 
   50.7
   


4. 
   55.3
   


5. 
   63.5
   

32. What is the yield to first call of the bonds?

1. 
   7.97%
   


2. 
   8.21%
   


3. 
   8.84%
   


4. 
   9.04%
   


5. 
   10.43%
   

33. The Duration of the bonds if held to first call is:

1. 
   3.4 years
   


2. 
   3.6 years
   


3. 
   6.0 years
   


4. 
   6.3 years
   


5. 
   6.6 years
   

34. The Convexity of the bonds if held to first call is:

1. 
   7.2
   


2. 
   12.6
   


3. 
   13.7
   


4. 
   15.0
   


5. 
   16.3
   

35. What is the yield to worst of the bonds?

1. 
   8.21%
   


2. 
   8.35%
   


3. 
   8.80%
   


4. 
   8.89%
   


5. 
   9.04%
   

36. What is the issuer’s “breakeven interest rate” for refinancing the bonds on December 15, 2024 if the issuer has a tax rate of 35% and the bond was issued at par?

1. 
   4.34%
   


2. 
   5.64%
   


3. 
   6.95%
   


4. 
   8.67%
   


5. 
   13.91%
   

37. Assuming interest rates or yields and credit quality remain at their current levels:

1. 
   It would be profitable for the issuer to refinance and call the bonds on July 15, 2024.
   


2. 
   It would NOT be profitable for the issuer to refinance and call the bonds on July 15, 2024.
   


3. 
   The issuer would be indifferent to refinancing and calling the bonds on July 15, 2024.
   


4. 
   All of the above answers are correct.
   


5. 
   None of the above answers is correct.
   

38. JP Morgan Chase issued a new 15-year Certificate of Deposit on June 24, 2020. The CD pays interest semi-annually beginning on December 24, 2020 at the rates shown in the table below. There is a floor of 0%. After June 24, 2021, the CD could best be classified as:

Year 1 Years 2-5 Years 6-10 Years 11-15

4.00% 4.50% − 6 month Libor 5.50% − 6 month Libor 6.00% − 6 month Libor

1. 
   A Floating Rate CD
   


2. 
   An Inverse Floater
   


3. 
   A Reset CD
   


4. 
   A PIK CD
   


5. 
   A Note Linked CD
   

Questions 39 through 42 are related and based on the data shown below:

A Note, call it Note X, was issued at par on March 15, 2020 and matures on March 15, 2028. Assume today is March 15, 2020. Interest is paid semi-annually on March 15 and September 15 according to the schedule shown below. The coupon rates vary over time but are fixed at the given rates. The next coupon is scheduled for September 15, 2020.

39. The Note X is best classified as:

1. 
   A Floating Rate Note
   


2. 
   An Inverse Floater
   


3. 
   A Reset Note
   


4. 
   A Step Up Note
   


5. 
   A Bond Linked Note
   

40. The Yield to Maturity of the Note X is:

1. 
   4.20%
   


2. 
   4.75%
   


3. 
   4.95%
   


4. 
   5.13%
   


5. 
   5.31%
   

41. The Duration of the Note X is:

1. 
   3.5 years
   


2. 
   5.6 years
   


3. 
   6.5 years
   


4. 
   6.9 years
   


5. 
   7.1 years
   

42. The Convexity of the Note X is:

1. 
   62.1
   


2. 
   56.3
   


3. 
   54.9
   


4. 
   53.7
   


5. 
   28.8
   

Another Note, call it Note Y, is also being issued at par on March 15, 2020 and matures on March 15, 2028. Assume today is March 15. Interest is paid semi-annually on March 15 and September 15 according to the schedule shown below. The coupon rates vary over time but are fixed at the given rates. The next coupon is scheduled for September 15, 2020. Notice the coupon rates are in reverse order from the previous Note.

43. Compared to Note X, Note Y:

1. 
   Should have a higher Yield to Maturity.
   


2. 
   Should have a lower Yield to Maturity.
   


3. 
   Should have the same Yield to Maturity.
   


4. 
   Cannot compare the yields to maturity from the information given.
   


5. 
   None of the above answers are correct.
   

44. Compared to Note X, Note Y:

1. 
   Should have a longer duration.
   


2. 
   Should have a shorter duration.
   


3. 
   Should have the same duration.
   


4. 
   Cannot compare the durations from the information given.
   


5. 
   None of the above answers are correct.
   

A recently issued Collateralized Mortgage Obligation has the expected cash flows as shown in the table below. It is the same data as seen on a class exhibit. The CMO is composed of 8% mortgages paying annually with 15 year terms. The CMO is priced at 102.75 and the yield to maturity is 7.50%.

45. The Duration of the CMO if held to maturity and the cash flows are as expected is:

1. 
   11.76 years.
   


2. 
   10.94 years.
   


3. 
   6.10 years.
   


4. 
   5.88 years.
   


5. 
   5.67 years.
   

46. The Convexity of the bonds if held to maturity and the cash flows are as expected is:

1. 
   24.95.
   


2. 
   26.86.
   


3. 
   46.48.
   


4. 
   49.97.
   


5. 
   53.72.
   

47. A Wall Street Journal article titled “Greece’s New Leaders Act Swiftly to Reverse Austerity” was published January 28, 2015. It included the following paragraph: “The moves scuttled the expectations of some European officials that Greece’s new leadership would retreat from its radical campaign platform after attaining power. Greek stocks plummeted more than 9%, with the country’s four main banks falling more than 25%. The yield on two-year debt rose by 2.63 percentage points—an enormous move by bond-market standards—to 16.5% as Greek bond prices tumbled.” The two-year bonds referenced have a coupon rate of 6.40%. Assume the bonds mature on June 15, 2017 and today is June 15, 2015 so accrued interest can be ignored. However, Eurobonds pay interest annually. When the yield increased, investors in the bonds would have experienced a:

1. 
   Capital Loss of 1.90%
   


2. 
   Capital Loss of 4.32%
   


3. 
   Capital Loss of 7.62%
   


4. 
   Capital Loss of 18.96%
   


5. 
   Capital Loss of 41.09%
   

48. After the yield increased to 16.5%, the Effective Duration of the Greek bonds referenced in question 47 is:

a. 0.3.

b. 1.0.

c. 1.4.

d. 1.7.

e. 3.3.

49. As of October 30, 2020, the Federal Reserve Bank balance sheet showed capital or “equity” of $39.2 billion. On the asset side, the Fed’s portfolio of securities included $3,792 billion of Treasury bonds, notes, and bills plus mortgage-backed securities. Assume the portfolio of Treasury securities has a modified duration of 5.3 years. Also, assume that if interest rates change, the Fed’s other assets and its liabilities will not change in value. That is not really true but the calculation is less complicated and at any rate, the changes of these other assets and liabilities will offset. Some analysts and critics believe financial institutions should “mark to market” [meaning their assets should be valued at market prices] to represent fairly the institution’s portfolio. If the Fed were required to “mark to market” like other financial institutions, how much would interest rates have to change to generate a capital loss on its securities portfolio large enough to eliminate the Fed’s capital?

1. 
   Interest Rates must rise 0.20%
   


2. 
   Interest Rates must rise 0.28%
   


3. 
   Interest Rates must rise 0.37%
   


4. 
   Interest Rates must rise 0.41%
   


5. 
   Interest Rates must rise 0.49%
   

50. The article titled “Risk of Ultra-Low Yields” includes the following information: “Low yields mean that more and more of the value of a bond is in the big lump sum investors get when the bonds mature, making prices more volatile. This is because the payment of that lump sum may be many years away, making the bond's value sensitive to assumptions about interest rates. That has made long-maturity bonds, such as 10-year or longer paper, even riskier than in the past. For a one-percentage point rise in yields, 10-year U.S. Treasury holders now face a drop in price of nearly nine percentage points, versus around seven under more normal yield assumptions. Moreover, given where yields are, there is more room for them to rise than fall, meaning losses are more likely. The benchmark 10-year Treasury was yielding around 1.95% on Friday [when the article was written], only a sliver more than inflation, which is running at 1.7%. If yields were to return to more normal levels of around 4%, investors would see the price of the bond fall from 97.15 on Friday to around 81, a fall of more than 16%, a huge hit for an asset many see as super safe.” If the 10-year Treasury, which pays interest semi-annually, had a yield to maturity of 1.95% and was priced at 97.15, the coupon rate on the bond would be:

a.

0.8175%

b.

1.635%

c.

3.270%

d.

4.875%

e.

8.175%

51.

Referring to the information from question 50, if the yield on the 10 year bond increases from 1.95% to 4% and the price of the bond falls from 97.15 to 81, then the modified duration of the 10 year Treasury would be:

a.

4.06 years

b.

4.16 years

c.

7.95 years

d.

8.11 years

e.

8.53 years

52.

Referring to the information from question 50, if the yield to maturity on the bond is currently 1.95% and inflation remains at its current rate of 1.7% annually over the term of the bond, then the annual real return or real interest rate or real yield of the bond would be:

a.

─0.25%

b.

0.25%

c.

1.70%

d.

2.20%

e.

3.65%