Free Series 7 Debt Securities Practice Questions

Topic summary

Debt securities questions usually combine math with risk. Start with issuer type, coupon, market yield, maturity, call features, credit quality, and customer objective before choosing the answer.

Common traps

• Reversing the inverse relationship between bond prices and market yields.
• Confusing current yield with yield to maturity or yield to call.
• Ignoring call risk on premium bonds.
• Treating high yield as suitable without checking credit risk and customer objective.

Free sample questions

1. A customer owns a 5% corporate bond. New comparable bonds are issued at 7%. What generally happens to the customer's bond price? Correct answer: It falls below par. Bond prices and market yields move inversely. If new comparable yields are higher than the existing coupon, the older lower-coupon bond usually trades at a discount.
2. A bond has a $60 annual coupon and trades at $1,200. What is its current yield? Correct answer: 5%. Current yield equals annual interest divided by market price. $60 / $1,200 = 5%. Do not divide by par when the question asks for current yield.
3. A bond purchased at a premium and held to maturity will generally have a yield to maturity that is what compared with its coupon rate? Correct answer: Lower than the coupon. A premium bond costs more than par but matures at par. That premium loss pulls yield to maturity below the stated coupon rate.
4. Which bondholder is most exposed to call risk? Correct answer: Owner of a premium callable bond when rates fall. When rates fall, issuers are more likely to call higher-coupon debt. A premium bondholder can lose the above-par premium sooner than expected and must reinvest at lower rates.
5. A zero-coupon bond is issued at a deep discount. How does the investor generally receive the return? Correct answer: Through appreciation toward par at maturity. Zero-coupon bonds do not make periodic coupon payments. The investor buys at a discount and receives par at maturity if the issuer pays as promised.
6. A bond rating is downgraded from investment grade to below investment grade. Which risk has most directly increased? Correct answer: Credit risk. A downgrade signals weaker credit quality and higher default risk. Higher yield may compensate investors, but it does not remove credit risk.
7. In a secondary-market bond trade between coupon dates, who usually pays accrued interest to whom? Correct answer: Buyer pays seller. The buyer compensates the seller for interest earned from the last coupon date through settlement. The buyer then receives the full next coupon from the issuer.
8. All else equal, which bond is usually more sensitive to interest-rate changes? Correct answer: Longer maturity bond. Longer maturities generally carry more interest-rate risk because cash flows are received farther in the future and price moves more when rates change.
9. A retired income investor wants predictable payments and low default risk. Which feature should be weighed most heavily? Correct answer: Credit quality and income stability. Income needs do not justify ignoring default risk. For a conservative income investor, credit quality, maturity, call features, and payment stability matter more than headline yield.
10. What feature distinguishes a convertible corporate bond from a straight corporate bond? Correct answer: It may be exchanged for common stock under stated terms. Convertible bonds include a conversion feature tied to the issuer's common stock. They still carry debt risks, but the conversion feature can add equity participation.