Fixed Income【Reading 55】Sample security, 2012, believe, government

burning0spear

Often central governments will announce auctions to issue new bonds when they believe prevailing market conditions appear most suitable. At the time of the auction, the amount to be auctioned and the maturity of the security to be offered are announced. This method of distributing new government securities is called:

A) an ad hoc auction method.

B) a regular auction cycle / single-price method.

C) the tap method.

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An ad hoc auction system is a method in which a central government distributes new government securities via auction when it determines that market conditions are advantageous.

ikoreaii

Which of the following does NOT represent a secondary market offering? When bonds are sold:

A) on an exchange.

B) in a Rule 144A offering.

C) in an over-the-counter dealer market.

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When bonds are sold in a Rule 144A offering, they are sold privately to a small number of investors or institutions. This offering does not require registration with the SEC and this is valuable to the issuer. The investor will require a slightly higher yield because the bonds cannot be resold to the public unless they are registered with the SEC. The other sales transactions in the responses represent secondary market offerings.

ikoreaii

When bonds are sold in a bought deal, the transaction takes place on the:

A) over-the-counter market.

B) secondary market.

C) primary market.

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When bonds are sold in a bought deal, the transaction takes place on the primary markets. In a bought deal, the investment banker buys the issue of bonds from the issuer and then resells them (i.e. they have underwritten the offer and the arrangement is termed a firm commitment). Bonds are sold in secondary markets after being sold the first time (after they have been issued in the primary market). The term over-the-counter does not apply.

ikoreaii

Which of the following does NOT represent a primary market offering? When bonds are sold:

A) on a best-efforts basis.

B) in a private placement.

C) from a dealer’s inventory.

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When bonds are sold from a dealer’s inventory, the bonds have already been sold once and the transaction takes place on the secondary market. The other transactions in the responses take place in the primary market. When bonds are sold on a best-efforts basis, the investment banker does not take ownership of the securities and agrees to sell all she can. In a private placement, the bonds are sold privately to a small number of investors.

ikoreaii

Anthony Schmidt, CFA, makes the following statements while discussing issuance of new debt:

Statement 1:	A best-efforts offering, which is a form of a negotiated offering, occurs when an investment banker purchases an entire issue to resell.
Statement 2:	Registration with the SEC can be avoided with a private placement, but a higher yield will be required to compensate for the limited liquidity.

Are Schmidt’s statements accurate?

A) Both of these statements are accurate.

B) Neither of these statements is accurate.

C) Only one of these statements is accurate.

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Statement 1 is incorrect. A firm commitment (not a best-efforts offering) is an arrangement where the investment banker purchases the entire issue and resells it.
Statement 2 is accurate. Under a private placement, a firm can avoid registration with the SEC, but the buyer will require a higher yield to compensate for the illiquidity of the issue.

ikoreaii

A debt security that is collateralized by various corporate bonds would be a(n):

A) TIP.

B) CDO.

C) CMO.

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A CDO (collaterized debt obligation) is a debt obligation that is backed by an underlying diversified pool of business loans, mortgages, emerging market debt, corporate bonds, asset-backed securities, or non-performing loans. A TIP is a Treasury Inflation-Protected Security. A CMO (collaterized mortgage obligation) is a debt obligation that is backed by mortgages.

ikoreaii

A CDO issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as a(n):

A) arbitrage CDO.

B) spread CDO.

C) balance sheet CDO.

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A CDO (collaterized debt obligation) issued to profit on the spread between the return on the underlying assets and the return paid to investors is referred to as an arbitrage CDO. A balance sheet CDO is created by a bank or insurance company wishing to reduce their loan exposure on the balance sheet. Spread CDO is a fabricated term.

ikoreaii

A debt security that is collateralized by emerging market debt would be a(n):

A) CMO.

B) MTN.

C) CDO.

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A CDO (collaterized debt obligation) is a debt obligation that is backed by an underlying diversified pool of business loans, mortgages, emerging market debt, corporate bonds, asset-backed securities, or non-performing loans. A MTN is a medium-term note issued by a corporation. A CMO (collaterized mortgage obligation) is a debt obligation that is backed by mortgages.

ikoreaii

The issuance of asset backed securities (ABSs) versus straight debt would be desirable if:

A) there are time constraints on the deal.

B) the corporation's credit rating may go up in the future.

C) a better credit quality is desired on the asset backed versus the corporation.

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If there are time constraints, straight debt would be easier to issue. Also, if the corporation could be upgraded, it would benefit in straight debt but not its ABSs.

ikoreaii

To reduce the cost of long-term borrowing, a corporation with a below average credit rating could:

A) issue asset backed securities.

B) decrease credit enhancement.

C) issue commercial paper.

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Commercial paper is a short-term promissory note. Decreasing credit enhancements increase the cost of borrowing.