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.

burning0spear

Fernando Golpas and Javier Solada were reviewing the financial reports of several Latin American governments. They noticed that the central governments of many Latin American countries such as Argentina, Chile, Peru, and Ecuador had recently been issuing sovereign debt. This sparked a discussion between the two analysts about sovereign debt ratings. During their discussion they made the following statements:
Golpas: The rating agencies, such as Moody's, generally assign two ratings to sovereign debt. One is a local currency debt rating and the other is a foreign currency debt rating. The reason for the two ratings is that the default frequency has been greater on local currency denominated debt.
Solada: If a central government is willing to raise taxes and control its internal financial system, it should be able to generate sufficient local currency to meet its local currency obligation. That is why the rating on local currency denominated debt is generally higher than the rating on foreign currency denominated debt.
With regard to the statements made by Golpas and Solada:

A) both are correct.

B) both are incorrect.

C) only one is correct.

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Golpas’ statement is incorrect because the reason for the two ratings (the local currency and the foreign currency debt ratings) is that the default frequency has been greater on foreign currency denominated debt. It is often easier for a central government to print local currency to meet its obligations in the home currency than to exchange the local currency in the foreign exchange markets for a given amount of foreign currency.

burning0spear

Which of the following statements regarding sovereign bonds is least accurate?

A) A central government can issue sovereign bonds in its national bond market, in another country’s foreign bond market, or in the Eurobond market.

B) When a central government issues securities, those securities can only be denominated in the local currency regardless of where the bonds are issued.

C) Sovereign bonds denominated in domestic currency are subject to default risk.

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When a central government issues securities, those securities are generally denominated in the currency of the issuing country, but a government can issue bonds denominated in any currency. Sovereign bonds are not necessarily free from default risk.

burning0spear

Which of the following is a difference between an on-the-run and an off-the-run issue? An on-the-run issue:

A) is publicly traded whereas an off-the-run issue is not.

B) is the most recently issued security of that type.

C) tends to sell at a lower price.

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An on-the-run issue is the most recently auctioned Treasury issue. An off-the-run issue older issues, when more current issues are brought to market.

burning0spear

A well-off-the-run Treasury security is best described as an issue:

A) that was traded within the last 12 months but has matured.

B) which has a yield that is out of line with similar maturity securities.

C) in a maturity range for which several more recent issues have been auctioned.

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On-the-run Treasuries are the most recent auctioned by the Treasury. When new issues are brought to market, older issues are called off-the-run issues. After a series of new issues in a given maturity spectrum, older issues of this original maturity are called well-off-the-run issues.

burning0spear

Given that a Treasury bond has a par value of $50,000 and is currently offered at a quoted price of 98:5, what is the dollar amount that an investor must pay in order to purchase the bond?

A) $98.16.

B) $4,907,812.50.

C) $49,078.13.

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If the quoted price is 98:5 this equals 98 5/32 which equals 98.15625% and means that the dollar amount is:
0.9815625 × $50,000 = $49,078.13

burning0spear

If an investor purchases a 9 ¾s 2001 Feb. $10,000 par Treasury Note at 101:11 and holds it for exactly one year, what is the rate of return if the selling price is 101:17?

A) 9.75%.

B) 8.75%.

C) 9.81%.

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Purchase price = [(101 + 11 / 32) / 100] × 10,000 = $10,134.375
Selling price = [(101 + 17 / 32) / 100] × 10,000 = $10,153.125
Interest = 9¾% of 10,000 = $975.00
Return = (Pend − Pbeg + Interest) / Pbeg = (10,153.125 − 10,134.375 + 975.00) / 10134.375 = 9.81%

burning0spear

Which of the following statements about U.S. Treasury Inflation Protection Securities (TIPS) is most accurate?

A) Adjustments to principal values are made annually.

B) The coupon rate is fixed for the life of the issue.

C) The inflation-adjusted principal value cannot be less than par.

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The coupon rate is set at a fixed rate determined via auction. This is called the real rate. The principal that serves as the basis of the coupon payment and the maturity value is adjusted semiannually. Because of the possibility of deflation, the adjusted principal value may be less than par (however, at maturity the Treasury redeems the bonds at the greater of the inflation-adjusted principal and the initial par value).

burning0spear

The annual payment of a 20-year, semi-annual pay bond with a $5,000 par value and a 6.875% coupon rate currently trading at 89.28 is closest to:

A) $343.75.

B) $171.88.

C) $153.45.

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$5,000 × 0.06875 = $343.75.

burning0spear

U.S. Treasury bonds that provide some protection from inflation by periodic adjustments of the principal value are called:

A) CPI Adjustable Bonds.

B) Inflation Linked Treasury Securities.

C) Treasury Inflation Protected Securities.

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Beginning in 1997, the U.S. Treasury began to offer Treasury Inflation Protected Securities, which are commonly known as TIPS. The principal value is periodically adjusted for changes in CPI. The periodic coupon payment, based upon the adjusted principal amount, reflects any changes in inflation.