Exam 8: Understanding Risk and Market Factors in Financial Securities

The market yield on a risky security is equal to the risk-free interest rate plus the risk premium. The higher the degree of default risk, the lower the risk premium.

A rise in the junk-bond spread indicates a growing fear among bond market investors that marginal-quality corporate borrowers are more likely to default on their debts.

Credit rating agencies typically release the same rating for securities.

The key factor determining the size of the call premium on callable bonds is the promised call price offered by the security's issuer.

The marketability of a security is:

Nearly all corporate bonds and mortgages and some U.S. government bonds issued in U.S. financial markets carry a call privilege.

New announcements that reflect decisions by the management of a corporation or other fund-raising unit are associated with a form of risk known as event risk.

When agency ratings on securities are different, the accepted practice is to take the highest rating and the lowest rating and average the results.

A pool of credit card loans is expected to pay the stream of cash flows for each quarter of the year indicated below. If the yield to maturity on comparable quality instruments is 14 percent, what should be the market value (price) of each security issued against this particular pool of credit-card loans?

Finance theory suggests that yield curves on higher-risk (speculative) corporate bonds tend to have a downward (negative) slope or are humped or bowed in shape. Why this might be true is that:

The failures of Argentina and Enron Corporation in 2001 reflect:

Marketability influences the yield a security issuer must offer in the secondary market.

When a company's common stock rises in price, its convertible bonds also tend to rise in price.

Default risk premiums are often called "quality spreads."

The concept of anticipated loss represents each investor's view of the appropriate risk premium on a security. If an investor faces the following situation, he or she would be inclined to buy the security: anticipated loss 6% risk-free rate 6% current yield to maturity 10%

Government uses its taxing power to encourage the purchase of certain financial assets and therefore redirects the flow of savings and investment towards areas of critical social need.

Marketability of a security is affected by the volume of similar securities available.

The highest marginal tax for individuals (single and married) is:

The marginal tax for people making $15,000 a year in taxable income is:

Marketability of a security is inversely related to the size and reputation of the institution issuing that security.