AFM 121 FINAL EXAM QUESTIONS AND ANSWERS WITH
COMPLETE SOLUTIONS GRADED A++
Fixed Income:
- Bonds, debentures, mortgages, swaps, preferred shares
- Fixed stream of cash flows with coupon payments over time and principal repayment
at maturity
Bonds:
Secured by specific assets, where bondholder can seize collateral in the event of
default
Debentures
Unsecured, so there is no collateral beyond the general income and assets of the
borrower
Bond Terms:
Terms are described in Bond Trust, which outlines the legal rights of the borrower (e.g.
the company) and the lender (e.g. the investor)
Includes: amount of coupon payments, date of principal repayments, covenants
Bond Prices
Based on face value (ex. $100)
Premium: pay $104 for $100 of face value
Discount: pay $96 for $100 of face value
Discount Bonds:
,Some do not include a coupon payment and are instead sold at discount, allowing
investors to earn difference between price and face value at maturity
Price changes are considered interest income for tax purposes (NOT capital gains)
Time Frames:
Short term: mature in 1 to 5 years
Medium term: mature in 5 to 10 years
Long term: mature over 10 years from now
Liquid Bonds:
Trade with large volume
Marketable Bonds:
Have an existing market
"off the run" bonds: older, no longer new
"on the run" bonds: newly issued
Bond Markets:
Bigger than equity market because it is measured by money traded
Government issues bonds, not shares
But there are more bonds than stocks, so each bond is less liquid
Bond Coupon Rates:
Floating Rate: adjusts periodically, such as resettling every 90-days to the government
90-day T bill yield
Fixed Rate: never adjusts for the entire life of the bond
Bond Maturity:
, Maturity rate can be modified by terms of the bond
Callable bonds: can be repurchased by issuer before maturity date (price of repurchase
set in bond trust)
Retractable bonds: can be "put" back to the issuer (bond holders force the repurchase)
Planned Repurchases:
Some bonds require the issuer to repurchase portions of the bond over time
Sinking fund: requires issuer to buy back bonds over time (not waiting until the lump
sum at maturity)
Purchase fund: requires issuer to buy back bonds over time as long as the bonds are
priced below par
Convertible Bonds:
Some bonds contain a provision that allows the bond to be converted to shares of the
issuer
Often used by less credit worth companies to give investors potential upside
Protective Provisions/ Covenants:
Restrict borrower's behavior
Limits total debt allowed
Violating covenant can lead to technical default, even if the borrower doesn't miss a
payment
Government Bonds:
Considered risk free
Treasure Bills: short term discount bonds
Marketable Bonds: medium and long term bonds with coupon payments
COMPLETE SOLUTIONS GRADED A++
Fixed Income:
- Bonds, debentures, mortgages, swaps, preferred shares
- Fixed stream of cash flows with coupon payments over time and principal repayment
at maturity
Bonds:
Secured by specific assets, where bondholder can seize collateral in the event of
default
Debentures
Unsecured, so there is no collateral beyond the general income and assets of the
borrower
Bond Terms:
Terms are described in Bond Trust, which outlines the legal rights of the borrower (e.g.
the company) and the lender (e.g. the investor)
Includes: amount of coupon payments, date of principal repayments, covenants
Bond Prices
Based on face value (ex. $100)
Premium: pay $104 for $100 of face value
Discount: pay $96 for $100 of face value
Discount Bonds:
,Some do not include a coupon payment and are instead sold at discount, allowing
investors to earn difference between price and face value at maturity
Price changes are considered interest income for tax purposes (NOT capital gains)
Time Frames:
Short term: mature in 1 to 5 years
Medium term: mature in 5 to 10 years
Long term: mature over 10 years from now
Liquid Bonds:
Trade with large volume
Marketable Bonds:
Have an existing market
"off the run" bonds: older, no longer new
"on the run" bonds: newly issued
Bond Markets:
Bigger than equity market because it is measured by money traded
Government issues bonds, not shares
But there are more bonds than stocks, so each bond is less liquid
Bond Coupon Rates:
Floating Rate: adjusts periodically, such as resettling every 90-days to the government
90-day T bill yield
Fixed Rate: never adjusts for the entire life of the bond
Bond Maturity:
, Maturity rate can be modified by terms of the bond
Callable bonds: can be repurchased by issuer before maturity date (price of repurchase
set in bond trust)
Retractable bonds: can be "put" back to the issuer (bond holders force the repurchase)
Planned Repurchases:
Some bonds require the issuer to repurchase portions of the bond over time
Sinking fund: requires issuer to buy back bonds over time (not waiting until the lump
sum at maturity)
Purchase fund: requires issuer to buy back bonds over time as long as the bonds are
priced below par
Convertible Bonds:
Some bonds contain a provision that allows the bond to be converted to shares of the
issuer
Often used by less credit worth companies to give investors potential upside
Protective Provisions/ Covenants:
Restrict borrower's behavior
Limits total debt allowed
Violating covenant can lead to technical default, even if the borrower doesn't miss a
payment
Government Bonds:
Considered risk free
Treasure Bills: short term discount bonds
Marketable Bonds: medium and long term bonds with coupon payments
