All of the following statements are true regarding gnma pass through certificates except:

All of the following securities trade with accrued interest EXCEPT:
a. Treasury bonds
b. Treasury STRIPS
c. Jumbo certificates of deposit
d. Convertible bonds

B
Securities that pay interest periodically or have a stated rate of interest (such as Treasury bonds, municipal bonds, corporate bonds, and certificates of deposit) trade "and interest" (with accrued interest). However, many money-market securities such as Treasury bills and bankers' acceptances trade at a discount and are therefore purchased without paying accrued interest. Zero-coupon bonds (i.e., Treasury STRIPS) do not pay periodic interest and are traded without accrued interest. (7-4)
STRIPS An acronym for 'separate trading of registered interest and principal securities'. Treasury STRIPS are fixed-income securities sold at a significant discount to face value and offer no interest payments because they mature at par.

Which of the following securities assist in financing importing and exporting operations?
a. Bankers' acceptances
b. Treasury bills
c. Eurodollar CDs
d. ADRs

A
Of the choices given, a bankers' acceptance (BA) is the only instrument that is used as a means of financing foreign trade. Do not confuse a BA with an ADR (American Depositary Receipt) which facilitates the trading of foreign securities in U.S. markets. Eurodollar certificates of deposit pay interest and principal in Eurodollars (U.S. dollars deposited in nondomestic banks) and are not used to finance importing and exporting operations. (7-21)

A U.S. government bond is selling in the market at 95.28. The dollar value of this bond is:
a. $950.87
b. $952.80
c. $958.75
d. $9,528.00

A
U.S. government bonds are quoted in 32nds. 95.28 would be equivalent to 95 28/32nds (28/32 = .875). This is equivalent to 95.875 percent of the par value of $1,000, which is $958.75. (7-2)

The bid price of a Treasury bond is $875. The bid price as quoted inThe Wall Street Journal would appear as:
a. 87.12
b. 87.16
c. 87.5
d. 87.8

B
U.S. Treasury bonds are quoted in 1/32nds of a point. If the bid price of a Treasury bond is stated at a dollar value of $875, it would mean that the bond is 87 1/2% of its par value of $1,000. Because 1/2 point in 32nds would be 16/32nds, the bid price as quoted in the paper would be 87.16. This would be the same as 87 1/2 or $875. In this question, we have to work backwards from the dollar value to the quote. In most other examples, you are given the quoted price of corporate or government bonds and are asked to find the dollar value. (7-2)

The tranche with the longest maturity, and therefore the last to receive interest and principal payments within a CMO, is known as the:
a. PAC tranche
b. Z-tranche
c. Supersinker
d. Companion tranche

B
The separate classes of a CMO are known as "tranches." The longest maturity is frequently called the Z-tranche or the "accrual bond," and does not receive interest or principal payments until the shorter maturing tranches have been retired. (7-19)
Z-TRANCHE (S7) : A type of CMO tranche that has the longest average life of any tranche.

All of the following are features of GNMA pass-through certificates EXCEPT:
a. They are backed by the U.S. government
b. Interest is subject to federal tax but is exempt from state tax
c. Interest and principal payments are made on a monthly basis
d. Pools consist of fixed-rate residential mortgages

B
The Government National Mortgage Association (Ginnie Mae) is an agency of the United States government. It guarantees a pool of mortgages purchased by investors through Ginnie Mae pass-through certificates. These instruments pay interest and principal monthly at a stated rate on the remaining principal. The repayment of principal and interest is guaranteed by the United States government. Ginnie Mae pass-through certificates are purchased in $25,000 minimums. Interest received from Ginnie Mae pass-through certificates is subject to federal, state, and local taxes. (7-13)

An article in The Wall Street Journal states that yields on Treasury bills have declined in the past month to 4.58% from 4.61%. This would indicate:
a. Buyers of new bills paid more than buyers paid the previous month
b. Buyers of new bills paid less than buyers paid the previous month
c. Interest rates are increasing
d. Buyers of new bills purchased the bills above par

A
Treasury bills are purchased at a discount from the dollar amount on its face. The larger the discount, the higher the discounted yield-to-maturity. In this example, the discounted yield-to-maturity has gone down to 4.58% from 4.61% from the previous month. This indicates that buyers of new bills paid more for the Treasury bills (meaning the discount was less) than buyers paid the previous month. (7-3)

A Treasury bond has increased in value from 98.4 to 98.8. The bond has increased by:
a. $.40 per $1,000 par value
b. $.50 per $1,000 par value
c. $1.25 per $1,000 par value
d. $5.00 per $1,000 par value

A
Treasury bonds are quoted in 32nds of a point, which are then calculated as a percentage of the par value ($1,000). The difference between 98.4 and 98.8 is 4/32. One point equals $10, therefore 4/32 or 1/8 of a point equals $1.25. (7-2)

An investor's goal is to buy a security that establishes a fixed return, for a long period of time, with no reinvestment risk. Which of the following best suits the investor's needs?
a. Treasury bills
b. Common stock
c. AAA corporate bonds
d. Treasury STRIPS

D
The typical yield-to-maturity calculation assumes that each interest payment is reinvested at the same yield. There would be no guarantee that the investor could reinvest at the same yield (reinvestment risk). Treasury STRIPS are zero-coupon bonds (long-term). Interest is automatically reinvested and compounded at the same yield and reinvestment risk is avoided. (7-4)

Treasury notes have initial maturities of:
a. Less than one year
b. 2 to 10 years
c. 11 to 30 years
d. More than 30 years

B
Treasury notes mature from two to ten years. (7-1)
1. T-bills have maturities of three months, six months or - less frequently - one year.
2. T-notes have maturities of two to 10 years.
3. T-bonds have maturities of more than 10 years.

A 3-month Treasury bill is issued at a discount to yield 9.5% and a corporate bond is issued to yield 9.5%. The bond is to mature in 10 years. If both are offered on the same day on a bond equivalent yield basis, which of the following statements is true?
a. The bill would have a greater yield than the bond.
b. The bond would have a greater yield than the bill.
c. The yield would be the same for both.
d. The bond equivalent yield and tax equivalent yield are equal.

A
T-bills are issued and quoted on a discount yield basis, whereas corporate bonds are quoted on a yield-to-maturity basis. These yields are calculated in different manners. The bond equivalent yield of a T-bill is always higher than its discount yield. (7-3)

Interest on all of the following may be subject to state taxes EXCEPT:
a. GNMA bond
b. Municipal bond
c. Corporate bond
d. Treasury note

D
Interest paid on corporate debt is subject to both federal and state taxes. Interest on municipal debt, especially if the buyer resides in a state different from the issuer, may be taxable. Interest on Treasury notes, as well as all direct U.S. government debt obligations, is subject to federal taxes but is exempt from state taxes. (7-8, 6-15, 8-1)

All of the following are guaranteed by the U.S. government EXCEPT:
a. Treasury notes
b. Treasury bills
c. Government National Mortgage Association (Ginnie Mae) certificates
d. Federal National Mortgage Association (Fannie Mae) bonds

D
Of the choices given, the only obligations that are not guaranteed by the U.S. government are FNMA (Fannie Mae) bonds. FNMA is a government chartered private corporation. It borrows funds and uses the proceeds to purchase conventional residential mortgages. Although FNMA can borrow funds from the U.S. government, the securities it issues are not backed by the U.S. government. (7-13)

A quote of 5.90 - 5.75 would be a quote for which of the following securities?
a. Treasury bills
b. Treasury notes
c. Treasury bonds
d. Debentures

A
Treasury bills are quoted on a discount yield basis while the other choices are quoted at a price. Since yield is inversely related (moves opposite) to price, the higher yield (5.90) represents the lower price and is the bid. The lower yield (5.75) represents the higher price and is the ask (offer). (7-3)

All of the following are true regarding negotiable CDs EXCEPT:
a. The minimum denomination is $100,000 but they commonly have face values of $1,000,000 or more
b. They are unsecured and normally have a fixed rate of interest
c. Owners can resell negotiable CDs in the secondary market
d. Maturities of more than one year are prohibited

D
Negotiable CDs are traded in the secondary market in minimum denominations of $100,000 but typically trade in $1,000,000 denominations. They are issued by commercial banks and are secured only by the bank's credit. Maturities of less than one year are common but there is no time limit. (7-22)

The U.S. government guarantees the payment of interest and principal for all of the following EXCEPT:
a. GNMAs
b. Treasury notes
c. Savings bonds
d. SLMAs

D
The U.S. government guarantees the payment of interest and principal on all Treasury securities, savings bonds, and securities issued by the Government National Mortgage Association (GNMA). Securities issued by the Student Loan Marketing Association (SLMA), a government-sponsored enterprise, are not guaranteed. Interest on GNMAs and SLMAs (also called Sallie Maes) is subject to federal tax, but state and local tax vary by state. (7-11)

All of the following are true of U.S. Treasury bills EXCEPT:
a. They do not have a stated rate of interest
b. They mature in one year or less
c. They are sold in $5,000 amounts
d. They are issued at a discount

C
All of the statements regarding Treasury bills are true except they are sold in $5,000 amounts. They are sold in minimum amounts of $100. Currently, Treasury bills are issued with maturities of 4, 13, and 26 weeks. (7-3)

All of the following securities are debt obligations of municipal governments EXCEPT:
a. Revenue bonds
b. General obligation bonds
c. Special tax bonds
d. Government National Mortgage Association (GNMA) bonds

D
All of the choices listed are types of municipal bonds except Government National Mortgage Association (Ginnie Mae) bonds. GNMA is a U.S. government agency which issues securities that are backed by the U.S. government. (7-13, 8-2, 8-10)

All of the following are true of Treasury bills EXCEPT:
a. They are exempt from state tax but are subject to federal tax
b. They are purchased at a discount from face value
c. Holders receive interest by clipping coupons which are attached to the bill
d. They have a dollar amount face value which the holder receives at maturity

C
All of the choices listed are true of Treasury bills except holders receive interest by clipping coupons which are attached to the bill. The interest received is the difference between the discounted purchase price and the face value received when the bill is redeemed at maturity. (7-3)

All of the following are true regarding commercial paper EXCEPT:
a. It is issued by a corporation for cash flow purposes
b. It is not backed by any of the corporation's specific assets
c. It is considered an exempt security if it matures in more than 270 days
d. It may be sold to the public by a broker-dealer or the issuer

C
Commercial paper is unsecured corporate debt with a maximum maturity of 270 days. Commercial paper is usually marketed through certain dealers but some corporations directly market their paper. Some issues are interest bearing (have a stated interest rate) but most are discount instruments. Corporations issue commercial paper to satisfy a short-term need for cash. (7-21)

A secondary market exists for:
a. Dealer-placed commercial paper
b. Federal funds
c. Repurchase agreements
d. U.S. savings bonds

A
A secondary market exists for owners of commercial paper to sell their investments to dealers or other investors. There is no secondary market for federal funds, repos, or U.S. savings bonds. (7-21)

The Federal Intermediate Credit Bank (FICB) makes:
a. Agricultural loans to farmers
b. Loans to finance residential mortgages
c. Business loans to veterans
d. Loans to railroads

A
The Federal Intermediate Credit Bank (FICB) makes agricultural loans to farmers. (7-11)
FEDERAL INTERMEDIATE CREDIT BANK (FICB) (S7) : A part of the Federal Farm Credit System that provides intermediate-term loans for agricultural purposes.

Which of the following securities would provide an investor with protection against purchasing power risk?
a. Treasury Bills
b. Treasury Notes
c. TIPS
d. STRIPS

C
Treasury Inflation-Protected Securities (TIPS) are U.S. government securities that are inflation-adjusted based on the Consumer Price Index (CPI). With TIPS the rate of interest is fixed; however, the principal amount on which that interest is paid will vary based on the CPI. They are usually purchased as protection against inflationary or purchasing power risk. The other choices are U.S. government securities that either pay an investor a fixed rate or amount. (7-2)

An investor buys $10,000 par value of 8% Treasury bonds due July 1, 2014. For tax purposes, the interest earned on these bonds is:
I. Subject to federal income tax
II. Exempt from federal income tax
III. Subject to state income tax
IV. Exempt from state income tax
a. I and III
b. I and IV
c. II and III
d. II and IV

B
Interest on U.S. government bonds is subject to federal income tax but exempt from state income tax. This is just the opposite of the tax treatment on municipal (state) bonds where the interest is exempt from federal tax, but may be subject to state tax. (7-1, 7-8)

All of the following statements apply to long-term (brokered) CDs EXCEPT:
a. They may have limited liquidity
b. Investors may be subject to interest-rate risk
c. They may be callable
d. The total amount of the investment is FDIC-insured

D
FDIC insurance may not apply to long-term CDs sold by broker-dealers if the face amount is in excess of $250,000. (7-22)

All of the following are TRUE of FNMA bonds EXCEPT they:
a. Can be issued in registered form
b. Can be issued in book entry form
c. Are a direct obligation of the U.S. government
d. Are generally a low-risk investment

C
Government Sponsored Enterprise (GSE) bonds, such as those issued by FNMA or FHCMC, are not direct obligations of the U.S. government. (7-10, 7-13)

A corporation has raised money to use for expansion of its plant within the next six months. In which of the following securities should the corporation invest the funds until they are utilized?
a. High-quality commercial paper
b. Long-term municipal zero-coupon bonds
c. U.S. Treasury bonds
d. High-quality preferred stocks

A
The corporation intends to use the money in a short period of time and would not want to assume undue investment risks. Of the choices given, the most suitable investment would be high-quality commercial paper since it is extremely safe and could be purchased with a short maturity to match the corporation's needs. (7-20)

If an issue of commercial paper is rated P-1 by Moody's, it is considered:
a. Speculative
b. Highest quality
c. Intermediate quality
d. On credit watch

B
P-1 (also called Prime 1) is the highest rating that Moody's will assign to commercial paper. Intermediate ratings are P-2 and P-3. Speculative commercial paper would receive a rating of NP (not prime). (7-21)

Which of the following is an example of a collateralized time draft?
a. Debenture
b. ADR
c. BA
d. Eurodollars

C
A BA (banker's acceptance) is used to facilitate foreign trade. It is a time draft which has been guaranteed (collateralized) by a bank. (7-21)

Collateralized mortgage obligations can be backed by securities issued by:
I. FNMA
II. GNMA
III. FHLB
IV. FFCB
a. I and II only
b. II and III only
c. I, II, and III only
d. I, II, III, and IV

A
CMOs can be backed by securities issued by FNMA, GNMA, and FHLMC. Federal Farm Credit Bank (FFCB) arranges loans for agricultural purposes. The Federal Home Loan Banks (FHLB) issues securities and uses the funds to provide liquidity for savings and loan institutions. (7-17)

All of the following are advantages of CMOs EXCEPT:
a. Various bond classes
b. Tax-free interest
c. AAA ratings
d. $1,000 denominations

B
The interest payments from a CMO are fully taxable. All of the other items would be considered advantages of CMOs. (7-17)

All of the following statements regarding commercial paper are trueEXCEPT it:
a. May be placed (sold) by a broker-dealer
b. May be directly placed by the corporation
c. Is issued by a corporation for cash flow purposes
d. Is backed by a pledge of a corporation's specific assets

D
All of the choices listed regarding commercial paper are true except it is secured by specific corporate assets. Commercial paper is a short-term unsecured promissory note of a corporation with a maximum maturity of 270 days. It is issued by a corporation for cash flow purposes. Commercial paper may be marketed through a broker-dealer (dealer placed) or by the corporation (directly placed). (7-21)

Which two of the following dates are used when calculating accrued interest on U.S. Treasury securities?
I. 30 days per month
II. Actual days per month
III. 360 days per year
IV. 365 days per year
a. I and III only
b. I and IV only
c. II and III only
d. II and IV only

D
U.S. Treasury securities use the actual calendar to calculate accrued interest. Corporate and municipal securities use a constant 30 day month and 360 day year method. (7-4, 6-14)

Treasury bills are issued to mature in all the following time framesEXCEPT:
a. One month
b. Three months
c. Six months
d. Nine months

D
Treasury bills mature in one month, three months, six months, or twelve months. They do not have nine-month maturities at issuance. (7-3)

Which of the following agencies could not be used to back a CMO?
a. FNMA
b. GNMA
c. SLMA
d. FHLMC

C
The Student Loan Marketing Association (SLMA), also known as Sallie Mae, provides liquidity to student loan makers and financing for state student loan agencies. Securities issued by SLMA are not backed by the U.S. government. Interest earned on Sallie Mae securities is subject to federal, state and local taxes. Since SLMA does not deal in mortgages, it would not be used to fund a collateralized mortgage obligation (CMO). CMOs contain mortgage-backed securities issued by GNMA, FNMA and FHLMC. (7-17)
STUDENT LOAN MARKETING ASSOCIATION (SLMA) (S7) : An agency that provides a secondary market for insured student loans made under the Guaranteed Student Loan Program. This private, for-profit corporation is also known as Sallie Mae.
COLLATERALIZED MORTGAGE OBLIGATION (CMO) (S7) : A type of security that attempts to customize the amount of prepayment risk associated with investments in mortgage-backed securities. The CMO creates bonds collateralized by a pool of mortgages or agency Pass-Through Securities. Each bond (called a Tranche) has a different rate of interest, repayment schedule, and priority level for receiving principal payments.

Which of the following is NOT backed by the credit of the U.S. government?
a. Treasury bills
b. Treasury STRIPS
c. Government National Mortgage Association (GNMA) bonds
d. Federal National Mortgage Association (FNMA) bonds

D
Federal National Mortgage Association (FNMA) bonds are issued by a privately owned organization and are not backed by the U.S. government. All of the other choices given are directly backed by the U.S. government. (7-13)
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) (S7) : A privately owned, NYSE-listed corporation, nicknamed Fannie Mae, that purchases residential, Federal Housing Administration, and Veterans Administration mortgages from savings institutions, and resells them by means of mortgage-backed securities. These securities are not guaranteed by the U.S. government.

These are best described as collateralized loans.
(Use the following choices to answer this question.)
a. Open-end investment company shares
b. Eurodollar bonds
c. Yankee bonds
d. Repurchase agreements

D
In a repurchase agreement, a dealer sells securities to another dealer and agrees to buy them back at a specific time and price. In effect, the selling dealer is borrowing money from the buying dealer and collateralizes the transaction with the securities. (7-22)

Which of the following are typically sold at a discount?
I. Commercial paper
II. Treasury bills
III. Bankers' acceptances
a. I and II only
b. I and III only
c. II and III only
d. I, II, and III

D
All of the short-term debt instruments listed are sold at a discount. (7-3, 7-21)

The minimum denomination for negotiable certificates of deposit is:
a. $1,000
b. $5,000
c. $10,000
d. $100,000

D
The minimum denomination for negotiable CDs is $100,000. Typical denominations are often $1,000,000 or more. (7-22)

Allen purchased a government security, and later discovered that it was nonnegotiable. This security could have been which of the following?
a. Treasury bill
b. Commercial paper
c. GNMA pass-through
d. EE savings bond

D
U.S. savings bonds, which include EE, HH, and I bonds, are nonnegotiable. This means purchasers cannot resell them to other investors in the secondary market. They can only be redeemed. (7-8)

When a corporation seeks a bank loan, on what rate will the bank base its charge to the corporation?
a. Prime rate
b. Federal funds
c. Discount rate
d. Call rate

A
A corporation pays the prime rate when borrowing from a bank if it is among the bank's best credit rated customers. Other corporations would pay a higher rate, but it would be based on the prime rate. (7-23)
PRIME RATE (S7) : The lowest interest rate charged by commercial banks to their most creditworthy and largest corporate customers.

Which of the following choices describes the greatest risk associated with mortgage-backed securities?
a. Borrowers might default on their mortgage payments.
b. The market for mortgage-backed securities is illiquid.
c. The market price of the bonds might fall due to a rating downgrade.
d. Falling interest rates might accelerate early repayment of principal.

A
Mortgage-backed securities are subject to prepayment risk. The early return of principal would then have to be reinvested when rates are low. Many mortgages that underlie mortgage-backed securities are backed by government guarantees or private mortgage insurance, which insulates many holders from defaults on the underlying mortgages. (7-14)
PREPAYMENT RISK (S7) : The risk that, due to falling interest rates, mortgage holders will pay off their mortgages at accelerated rates. For the holder of mortgage-backed securities, this occurrence may greatly affect their overall return.

Which of the following trade without accrued interest?
a. Municipal bonds
b. Treasury bills
c. Debentures
d. Convertible bonds

A
Treasury bills do not trade with accrued interest. They are issued at a discount and mature at par. (7-3)
TREASURY BILLS (T-BILLS) (S7) : Short-term obligations of the U.S. government. They have 4-week, 13-week, 26-week, and 52-week maturities. They are purchased at a discount and mature at face value. The difference between the purchase price and maturity value (the amount of the discount) is considered interest.

An investor purchasing $1,000,000 par value of Treasury notes at a price of 101-03 would pay:
a. $1,010,300
b. $1,010,937.50
c. $10,101,300
d. $10,109,375

B
Treasury notes are quoted as a percentage of par in 32nds of a percent. A quote of 101-03 equals 101 3/32% or 101.09375% (3/32 = .09375). 101.09375% x $1,000,000 = $1,010,937.50. (7-2)
TREASURY NOTES (S7) : U.S. Government obligations with original maturities of more than one year up to ten years. They are issued in $1,000 denominations and pay interest semiannually.

A client is seeking a safe investment that pays interest on a monthly basis. Which of the following would be an appropriate recommendation?
a. Income bonds
b. Preferred stock issued by a blue chip corporation
c. Treasury notes
d. GNMA modified pass-through certificates

D
Interest (and principal) payments on GNMA pass-through certificates are made monthly. Treasury notes and bonds pay interest semiannually. Preferred stock dividends are paid to shareholders only when declared by the corporation's board of directors. Income (adjustment) bonds only pay interest when a corporation has sufficient earnings. (7-12)

A Treasury bond is quoted 105.04 - 105.24. The purchase price that a customer would expect to pay would be:
a. $1,051.25
b. $1,052.40
c. $1,054.00
d. $1,057.50

D
U.S. Treasury notes and bonds are quoted in 32nds of a point. When purchasing the bond, the customer would pay the offering price of 105.24. To convert 105.24 into a dollar price:
step 1: 105.24 is equal to 105 24/32
step 2: convert 24/32 into a decimal, which is .75
step 3: convert 105.75% into a dollar price
(105.75% x $1,000 = $1,057.50)
The customer would pay $1,057.50. (7-2)

A registered rep wishes to prepare advertising to be sent to clients concerning the investment merits of CMOs. In this piece, the rep plans to compare CMOs to other types of investments so that clients will better understand the product. According to industry rules, which of the following statements regarding the advertising is correct?
a. Such advertising would be prohibited due to the diverse audience likely to receive it.
b. The rep may prepare the ad and compare CMOs to other investments if the comparison helps the product to be better understood by clients.
c. The rep may prepare the ad but may only compare CMOs to similar products such as mortgage pools.
d. The rep may prepare the ad but may not compare CMOs to any other security.

D
Communications concerning CMOs may not make comparisons between CMOs and other products. Also, all such communications must offer educational material describing CMOs. (7-19)

All of the following are part of the Federal Farm Credit SystemEXCEPT:
a. Banks for Cooperatives
b. Federal Intermediate Credit Banks
c. Federal Land Banks
d. Federal National Mortgage Association

D
The Federal Farm Credit System is composed of the Banks for Cooperatives, Intermediate Credit Banks, and Federal Land Banks. (7-11, 7-13)
FEDERAL FARM CREDIT SYSTEM (S7) : A group of government agencies that extend credit to farmers. The system will raise money by selling debt instruments. See also: Banks for Cooperatives; Federal Intermediate Credit Banks; Federal Land Bank.
BANKS FOR COOPERATIVES (S7) : A government-sponsored, privately owned enterprise that is part of the Federal Farm Credit System. It provides short-term loans to farmers' cooperative associations. See also: Federal Farm Credit System.
FEDERAL LAND BANK (FLB) (S7) : A part of the Federal Farm Credit System. It provides long-term loans to farmers and ranchers for various agricultural purposes.

Which of the following best describes a BA?
a. It facilitates the trading of foreign stocks in the United States.
b. It helps to finance foreign trade between importers and exporters.
c. It is used by a municipal issuer in raising funds to meet a seasonal need for cash.
d. It is issued by nondomestic banks and is secured by Eurodollar deposits.

B
Bankers' Acceptances (BAs) help facilitate foreign trade. ADRs permit the trading of foreign stocks in the U.S. (7-21)
BANKERS ACCEPTANCE (BA) (S7) : A money-market instrument used to finance international and domestic trade. It is a check drawn on a bank by an importer or exporter of goods representing the bank's unconditional promise to pay the face amount of the note at maturity.

An individual with $10,000 to invest would not usually be able to purchase:
a. Money-market fund shares
b. Dealer-placed commercial paper
c. Municipal bonds
d. Treasury STRIPS

B
The minimum requirement for an investment in dealer-placed commercial paper is normally $100,000. The minimum requirement for investment in Treasury STRIPS is usually $1,000 and the minimum denomination for municipal bonds is $1,000. (7-21)

Government-sponsored enterprise securities are comparable to direct government obligations with regard to all of the following EXCEPT:
a. They trade in the over-the-counter market
b. All are government guaranteed
c. Short-term securities are quoted on a discount yield
d. Long-term securities are quoted as a percentage of par

B
Government-sponsored enterprise securities are not guaranteed by the government. (7-11)

A GNMA pass-through is quoted 98.10 to 98.18. This quote represents a spread per $1,000 face value of:
a. $0.08
b. $0.80
c. $2.50
d. $8.00

C
GNMA pass-through certificates (like T-notes and T-bonds) are quoted in 32nds. The spread of .08 represents 8/32 or 1/4 (.25) and has a value of $2.50 per $1,000. (7-11, 7-2)

When evaluating two CMOs backed by GNMAs, one having a 6% yield and the other having a 10% yield, which of the following is/are TRUE?
I. Prepayment risk is greater for the CMO with the 10% yield.
II. Prepayment risk is greater for the CMO with the 6% yield.
III. Credit risk is greater for the 10% CMO.
a. I only
b. II only
c. I and III only
d. II and III only

A
Prepayment risk measures the possibility that homeowners will refinance (prepay) their mortgages. Historically, the speed of prepayment increases when interest rates fall. If this happens, payments will flow into the CMOs at an accelerated rate, forcing investors to reinvest these monies at lower than anticipated rates. Therefore, the CMO with the higher interest rate will have higher prepayment risk.
GNMA-backed CMOs are AAA rated and therefore have little credit risk. Since both CMOs are backed by GNMAs, credit risk is nonexistent for both pools. (7-14)

An investor purchased a $10,000 Treasury bond that has an 8% coupon and matures 11-1-26. He purchased the bond on Monday, September 10, 201X for regular-way settlement. He sold the bonds on February 11th of the next year for cash settlement. What amount of interest income was taxable in 201X?
a. $108.50
b. $245.50
c. $335.34
d. $400.00

A
When the investor purchased the bond on September 10th, he paid the seller accrued interest from the last interest payment date, up to but not including the settlement date of September 11th. The last interest payment date was May 1st. The buyer therefore owed the seller for 133 days of accrued interest (May = 31 days, June = 30 days, July = 31 days, August = 31 days, September = 10 days). To determine the dollar amount paid, multiply the annual interest payment of $800 by the portion of the year in question:
$800 x 133/365 = $291.50
This means that when the buyer received his $400 semiannual interest payment on November 1, $291.50 represented the amount he paid to the seller and $108.50 represented interest income. Only the interest income of $108.50 received that year is taxable to the investor. (7-4, 6-13)

An investor owns Treasury bonds which mature in 20 years. This investor will be exposed to:
a. Credit risk
b. Inflationary risk
c. No risk
d. Capital risk

B
Credit risk is the risk that the investor will not receive interest and/or principal when it is due. Capital risk is the risk that the investor will lose his investment. Since Treasury bonds are direct obligations of the U.S. government, there is no risk that the investor would not receive interest and/or principal when due or lose his investment. Therefore, the investor is free of credit and capital risk. All fixed-income securities expose an investor to inflationary risk (purchasing power risk). (7-1, 5-15)

Which two of the following are TRUE relating to the notes issued by the Federal Farm Credit Banks Consolidated System?
I. They are issued at a discount.
II. They are issued at par.
III. They are interest bearing.
IV. They are non-interest bearing.
a. I and III only
b. I and IV only
c. II and III only
d. II and IV only

B
The Farm Credit Banks issue consolidated systemwide notes which are issued at a discount (like T-bills) and are non-interest bearing. Bonds are also issued which are interest bearing (have a stated interest rate). Interest is subject to federal taxation but is exempt from state and local taxation. (7-11)

All of the following money market instruments trade in the secondary market EXCEPT:
a. Directly placed commercial paper
b. Eurodollar CDs
c. Repurchase agreements
d. Bankers' acceptances

C
Repurchase agreements typically are not traded in the secondary market. Eurodollar CDs are certificates of deposit payable in Eurodollars (U.S. currency on deposit in foreign banks). Eurodollar CDs are traded in the secondary market. (7-20)
REPURCHASE AGREEMENT (REPO OR RP) (S7) : A negotiated transaction in which a securities dealer sells a security (typically U.S. Treasuries) with the agreement to repurchase them after a relatively short period at a predetermined price.

Which of the following securities would be most appropriate for an investor seeking to buy a new home within the next year?
a. A long-term CD purchased in the secondary market, with 2 years to maturity, but callable in six months
b. A newly issued 20-year bond callable in six months
c. A newly issued non-callable 5-year Treasury note
d. A long-term CD purchased in the secondary market, that matures in 12 months

D
In general, the most liquid securities are money-market securities (those that mature in a year or less). Securities with longer maturities tend to be more volatile. Even if a security is callable, there is no guarantee that the call will take place. If interest rates are rising, bond prices will fall, and call features are unlikely to be exercised by issuers. (7-20)

Which TWO of the following may be included in the STRIPS program to create zero-coupon securities?
I. Treasury bills
II. Treasury notes
III. Savings bonds
IV. Treasury bonds
a. I and III
b. I and IV
c. II and III
d. II and IV

D
Treasury STRIPS are created when Treasury notes and Treasury bonds are separated (stripped) of their coupons. Treasury bills and savings bonds are not permitted to be stripped. (7-4)

The current yield for a 9% Treasury bond trading at 101:14 is:
a. 8.77
b. 8.87
c. 8.90
d. 8.93

B
Current yield is the interest rate divided by the asked price. It is 8.87% (9% interest rate divided by the asked price of 101 14/32 or 101.4375). Treasury bonds are quoted as a percentage of par in 32nds of a point. (7-2, 5-7)

CURRENT YIELD (S7) : A security's annual income divided by its current market price.

TREASURY BONDS (S7) : U.S. government obligations with original maturities of more than 10 years. They are issued in $1,000 denominations and pay interest semiannually.

XYZ Corporation borrows money at a rate of interest that is one point above LIBOR. Therefore, the rate is based on:
a. A long-term bond index
b. The U.S. prime rate
c. The London Interbank Offered Rate
d. A rate established by the Federal Reserve .

C
LIBOR is the London Interbank Offered Rate. It is the average rate that banks charge each other on loans for London deposits of Eurodollars. (7-23)

Collateralized Mortgage Obligations (CMOs) make interest payments to investors:
a. Daily
b. Weekly
c. Monthly
d. Quarterly

C
CMOs are issued in minimum denominations of $1,000, are backed by pass-through securities (FNMA, GNMA, and FHLMC), and pay interest and principal monthly. (7-17)

Which of the following statements is TRUE concerning the tax treatment of CMOs?
a. The interest and principal are fully taxable.
b. The interest is fully taxable.
c. The interest is exempt from state and local taxes.
d. The interest and principal are exempt from state and local taxes.

B
The interest received from CMOs is fully taxable (federal, state, and local taxes). The principal payments are considered a return of capital and not taxable. Investors receive their principal payments every month instead of at maturity. (7-17)

Which of the following securities would have prepayment risk?
a. Common stock of a Fannie Mae
b. Bonds issued by Freddie Mac
c. Collateralized Mortgage Obligations
d. Commercial Paper

C
Many homeowners pay off their mortgages early. When interest rates fall, homeowners have an incentive to refinance and pay off their existing mortgages. These prepayments are passed through to the pools holding the old mortgages. The investors then need to reinvest this large amount of principal at a time when interest rates have declined.

This is referred to as prepayment risk and it is associated with mortgage-backed securities such as CMOs. Although both Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed securities, in this question choices (a) and (b) are common stock and bonds of these issuers, which would not have prepayment risk. (7-14)

C
Many homeowners pay off their mortgages early. When interest rates fall, homeowners have an incentive to refinance and pay off their existing mortgages. These prepayments are passed through to the pools holding the old mortgages. The investors then need to reinvest this large amount of principal at a time when interest rates have declined. This is referred to as prepayment risk and it is associated with mortgage-backed securities such as CMOs. Although both Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed securities, in this question choices (a) and (b) are common stock and bonds of these issuers, which would not have prepayment risk. (7-14)

D
In a repurchase agreement (repo), a dealer sells securities (usually T-bills) to an investor and agrees to repurchase them at a specific time, at a specified price. In effect, the dealer is borrowing funds from an investor and securing the loan with securities (a collateralized loan). The investor (the lender) receives the difference between the purchase price and the resale price of the securities in return for making the loan.
If a dealer purchases securities and agrees to sell them back to an investor at a specific date and price, this is known as a reverse repo or matched sale. In this situation, the dealer would lend funds (with securities as collateral) to the investor and earn the difference in sales prices. Many corporations and financial institutions, as well as dealers, engage in repos and reverse repos. Repos and reverse repos are typically short-term, with most being overnight transactions. (7-22)

Which two of the following statements are TRUE concerning step-down, long-term certificates of deposit?
I. The initial interest rate is below market rates.
II. The initial interest rate is above market rates.
III. The final interest rate is higher than the initial rate.
IV. The final interest rate is lower than the initial rate.
a. I and III
b. I and IV
c. II and III
d. II and IV

D
A step-down, long-term certificate of deposit will offer an investor an interest rate that is initially higher than current market rates will pay for that maturity period. Subsequent interest rates paid to investors would be lower and may be adjusted more than once. Long-term CDs have a maturity of more than one year. An RR should disclose to the client that she will not receive the higher interest rate for the life of the CD. (7-22)

A client purchases a step-up, long-term certificate of deposit. The initial interest rate offered would:
a. Be higher than current market rates
b. Be lower than current market rates
c. Offer the client protection from interest-rate risk
d. Offer the client protection against call risk

B
A long-term (maturity exceeding one year), step-up CD will offer an investor an interest rate that is initially lower than current market rates will pay for that maturity period. The rate will then be adjusted upward at predetermined intervals established by the offering bank. Since they are traded in the secondary market, changes in interest rates will cause the price of this security to fluctuate. Some long-term CDs will be callable by the issuing bank, and the investor may be required to reinvest the funds at prevailing lower interest rates. (7-22)

Which of the following statements is NOT TRUE concerning the Student Loan Marketing Association (Sallie Mae)?
a. It issues securities that can be redeemed to pay for college education.
b. It issues securities that are not backed by the U.S. government.
c. It purchases federally sponsored student loans.
d. It provides loans to educational institutions.

A
The Student Loan Marketing Association (known as SLMA or Sallie Mae) provides liquidity to student loan makers by purchasing federally sponsored student loans. It will also lend funds directly to educational institutions. Sallie Mae securities are not backed by the full faith and credit of the U.S. government, but the SLMA maintains a direct line of credit with the U.S. government. It does not issue securities that can be redeemed to pay for college education. (7-11, 7-12)

Repos and reverse repos would most likely be used by:
a. A municipality borrowing to build a new highway
b. Institutions that have a need to borrow on a short-term basis, or have money to lend on a short-term basis
c. Corporations issuing stock to raise money
d. Importers and exporters in connection with foreign trade, which represents money to be paid in the future and is guaranteed by a bank

B
In a repurchase agreement a firm sells securities to another firm and agrees to repurchase them at a specific time and a specific price, which produces an agreed-upon rate of return. In effect, one firm is borrowing money from the other with securities as collateral. (7-22)

Which of the following risks is considered unique to an investor holding a CMO?
a. Prepayment risk
b. Credit risk
c. Interest-rate risk
d. Reinvestment risk

A
The risk that an investor will receive her principal earlier than projected instead of at one time (prepayment risk) is the most important risk concerning mortgage-backed securities such as CMOs. Although all fixed-income securities will have interest-rate risk, prepayment risk is unique to CMOs. Most CMOs are rated AAA due to the underlying mortgages backing these securities. (7-14)

Long-term Certificates of Deposit have which of the following characteristics?
a. They may only be sold by broker-dealers that are subsidiaries of banks.
b. They are considered risk-free investments.
c. They may be sold prior to maturity at a price that is different from the client's original cost.
d. They are not subject to interest-rate risk since the principal is insured by the FDIC.

C
Long-term CDs have a maturity of more than one year. Since the securities are traded in the secondary market, changes in interest rates will cause price fluctuations. If sold prior to maturity, a CD investor may have a loss or gain. Long-term CDs are issued by banks, but may be sold by any type of broker-dealer. The FDIC provides protection of up to $250,000. (7-22)

The PSA Model is used when pricing:
a. Put options
b. Preferred stock
c. Collateralized Mortgage Obligations
d. Treasury Notes

C
The cash flows or future payments that a bondholder will receive determine the market price of the bond. Collateralized Mortgage Obligations (CMOs) have uncertain cash flows due to the prepayments (early retirement) of mortgages. Prepayment risk is the risk homeowners will pay off their mortgages early and the clients who invested in the securities backed by the mortgage will receive their principal prior to maturity. The Public Securities Association (now SIFMA), an association of financial services firms, created a standard model for estimating the prepayment rate for mortgage-backed securities including CMOs. This is called the PSA Model. (7-17)

If a CMO has a PSA of 150, which of the following events most likely has occurred?
a. Interest rates have increased.
b. Interest rates have decreased.
c. The credit rating of the issuer has been lowered.
d. There has been an increase in the secondary market trading of the securities.

B
The PSA Model is used for CMOs and estimates the speed of prepayments as measured against a benchmark. A PSA of 100 assumes that the prepayment speed will remain stable, while a PSA greater than 100 assumes faster prepayments. Conversely, a PSA that is less than 100 indicates slower than normal prepayment speed. If interest rates decline, homeowners often refinance and prepayments of mortgages increase. The credit rating or trading activity does not influence the PSA Model. (7-17)

Which of the following credit rating organizations does not determine the credit strength of corporate debt with a maximum maturity of 270 days?
a. Fitch
b. A.M. Best
c. Standard & Poor's
d. Moody's

B
Commercial paper is usually defined as a short-term debt security with a maximum maturity of 270 days. Fitch, Standard & Poor's, and Moody's are three of the main rating organizations that assign ratings for commercial paper. These companies rate commercial paper based on the credit strength of the issuer. A.M. Best is a ratings organization that assigns ratings to insurance companies. (7-21)

Which TWO of the following statements are TRUE regarding brokered CDs sold by registered representatives?
I. These instruments are insured by the FDIC if the issuer declares bankruptcy.
II. These instruments are covered by SIPC if the issuer declares bankruptcy.
III. These instruments are insured by the FDIC if the broker-dealer declares bankruptcy.
IV. These instruments are covered by SIPC if the broker-dealer declares bankruptcy.
a. I and III
b. I and IV
c. II and III
d. II and IV

B
Long-term or brokered CDs generally have maturities from 2 to 20 years and are, therefore, not considered money-market securities. These instruments are issued by banks and, although sold by broker-dealers, they are insured up to certain limits by the FDIC if the issuing bank declares bankruptcy. If the broker-dealer that sold the brokered CD to the client declared bankruptcy, SIPC coverage would apply since these products are defined as securities. (7-22)

Which TWO of the following statements are TRUE regarding brokered CDs sold by registered representatives?
I. A callable CD gives the investor the right to redeem the security prior to maturity.
II. If the CD is called by the issuer, the client may not be able to receive a comparable rate of interest.
III. A callable CD that is called prior to maturity may offer a client a return that is less than the yield to maturity.
IV. Since the security is issued by a bank, a callable CD will provide no limit to the amount of FDIC insurance.
a. I and III
b. I and IV
c. II and III
d. II and IV

C
When a client purchases a brokered or long-term CD issued by a bank, the broker-dealer offering the product is required to provide a client with certain disclosures. These disclosures would be based on the potential risk and investment considerations relevant to the client. The following disclosures should be made concerning callable CDs.
• The issuer at its sole discretion may decide to call in the CD prior to maturity; therefore, the client does not have the right to redeem the CD prior to maturity.
• If the CD is called prior to maturity, the client may be unable to reinvest the funds and receive a comparable rate of interest (if rates have declined).
• A CD that is called prior to maturity may offer a client a return that is less than the yield to maturity.
• The CD may not be called by the issuer, requiring the client to hold the security until maturity.
All brokered CDs carry limited FDIC insurance if the amount of the CD at one bank exceeds the regulatory limits established by the FDIC. (7-22)

Which of the following factors is least important when recommending a long-term brokered CD to a client?
a. The CD was issued by a bank located in a different state from where the client lives.
b. The CD has a feature in which the interest rate is based on a percentage increase in an equity index.
c. The client will be purchasing the CD in a retirement account.
d. The firm may make a market in this CD, but is not obligated to do so.

A
The state in which the client or issuing bank is located is not an important factor when recommending a long-term brokered CD. The features that establish the interest rate of the security, such as an index of fixed-income or equity securities, is relevant to the client. The amount of FDIC insurance and tax considerations are different depending on whether the CD is purchased in a retirement account. In addition, a broker-dealer is not required to maintain a secondary market or act as a market maker in a CD that was sold to the client. This will limit the liquidity of the security if the client needs the funds prior to maturity. (7-22)

Which of the following statements is TRUE concerning the tax treatment of CMOs?
a. The interest is fully taxable.
b. The principal is fully taxable.
c. The interest is exempt from federal tax but subject to state and local taxes.
d. The interest and principal are exempt from state and local taxes.

A
The interest received from collateralized mortgage obligations (CMOs) is fully taxable (federal, state, and local taxes). The principal payments are considered a return of capital and are not taxable. Investors receive their principal payments each month instead of receiving the entire amount of principal at maturity. (7-17)

A broker-dealer is preparing sales literature on CMOs. Which TWO of the following statements must be disclosed?
I. The term collateralized mortgage obligation must be included within the name of the product.
II. The basis point spread above a comparable Treasury security the client will receive in interest must be included.
III. The lower of the yield to call or yield to maturity must be included.
IV. The government agency backing only applies to the face value of the securities.
a. I and III
b. I and IV
c. II and III
d. II and IV

B
Advertising, sales literature and correspondence about collateralized mortgage obligations (CMOs) are subject to special rules. The term collateralized mortgage obligation must be included within the name of the product and it must disclose that the government agency backing only applies to the face value of the securities (not any premium paid). If the client paid a premium to purchase a CMO, only the par value would be backed by the entity backing the security. The actual coupon rate, not the spread above Treasuries, needs to be disclosed. Due to the prepayment risk of CMOs, the yield to average life would be disclosed, not the yield to maturity or yield to call. (7-19)

Which of the following statements is TRUE concerning the disclosure requirements in CMO correspondence?
a. A comparison between a CMO and an AAA-rated corporate bond is permitted.
b. A comparison between a CMO and a municipal bond is permitted if the client is in a high tax bracket.
c. A comparison between a CMO and a bank certificate of deposit is permitted if the bank is FDIC-insured.
d. A comparison between a CMO and a bank certificate of deposit is not permitted under any circumstances.

D
Due to their unique characteristics, CMOs may not be compared to any other types of investment, including a certificate of deposit. This prohibition applies to any communication with the public about CMOs, which includes advertising, sales literature, and correspondence. (7-19)

When determining whether a CMO is suitable, an RR must offer to a client all of the following information EXCEPT a:
a. Glossary of terms
b. Discussion on how changing interest rates may affect the prepayment rates
c. Discussion on how changing currency rates may affect the value of the securities
d. Discussion on the relationship between mortgage loans and mortgage securities

C
Broker-dealers must offer customers educational material about the features of CMOs. This material must include:
• A discussion of the characteristics and risks of CMOs. This would include: how changing interest rates may affect prepayment rates and the average life of the security, tax considerations, credit risk, minimum investments, liquidity, and transactions costs.
• A discussion of the structure of a CMO. This would include the different types of structures, tranches, and risks associated with each type of security. It is also important to explain to a client that two CMOs with the same underlying collateral may have different prepayment risk and different interest-rate risk.
• A discussion that explains the relationship between mortgage loans and mortgage securities
• A glossary of terms applicable to mortgage-backed securities
Changing currency rates are not applicable to the risks associated with CMOs. (7-20)

Which of the following risks for an agency backed CMO would be least important to an investor in a rising interest rate environment?
a. Prepayment risk
b. Credit risk
c. Interest-rate risk
d. Extension risk

A
Prepayment risk is associated with a falling interest rate environment in which mortgage holders refinance or repay their mortgages at a faster rate. The holder of a CMO, therefore, receives a larger portion of the principal earlier than anticipated and is forced to reinvest at lower rates.

Many CMOs are created from government agency MBS which have a minimal amount of credit risk. Some CMOs are constructed without this backing and therefore credit risk is a greater concern.

CMOs, like most fixed-income securities, carry interest-rate risk. Extension risk is the opposite of prepayment risk, where interest rates are rising and the CMO holder receives a smaller portion of her principal back. (7-14)

A CMO would be suitable for an investor seeking:
a. Monthly tax-free income assuming he does need the principal returned at maturity
b. Quarterly income assuming he does not need the principal returned at maturity
c. Monthly income assuming he needs the entire principal returned at maturity
d. Monthly income assuming he does not need the entire principal returned at maturity

D
CMOs pay monthly income made up of interest, which is taxable, and principal, which is a tax-free return of capital. Due to the structure of a CMO, a fluctuating amount of principal is returned monthly, not at maturity, which makes CMOs different from most other fixed-income securities. (7-17)

Which TWO of the following choices are TRUE regarding the types of securities issued by the Federal Home Loan Bank?
I. Discount notes with maturities between 2 and 10 years
II. Discount notes with maturities of less than one year
III. Consolidated bonds with maturities of up to 30 years
IV. Consolidated bonds with maturities ranging from10 to 30 years
a. I and III
b. I and IV
c. II and III
d. II and IV

C
The Federal Home Loan Bank issued two types of securities to raise capital, discount notes with maturities of less than one year, and consolidated bonds with maturities of up to 30 years. These funds are used to lend funds to FHLB member banks which, in turn, lend these funds to their customers. (7-12)

Which of the following statements are true regarding GNMA pass through certificates?

Which risk is not applicable to Ginnie Mae pass through certificates?

Which statement is true about the government National mortgage Association GNMA )?

What is not a risk of investing in a GNMA quizlet?