Debt Securities — Series 7 FINRA practice questions

Which security is a direct obligation of the U.S. Treasury?

1. A Fannie Mae bond
2. Ten-year Treasury note
3. Ginnie Mae pass-through
4. FHLB discount note

Answer: B — Ten-year Treasury note

A) Fannie Mae is a GSE. B) Correct — full faith and credit backing. C) GNMA is guaranteed, issued by lenders. D) FHLB is a GSE.

TIPS with 1.5% coupon. Principal adjusts with CPI. If CPI rises 3%, dollar coupon paid:

1. Rises because principal was adjusted upward
2. Stays flat since the coupon rate is fixed
3. Falls because premium amortization increased
4. Rises because rate is indexed to inflation index

Answer: A — Rises because principal was adjusted upward

A) Correct — coupon rate stays at 1.5% but is applied to a higher adjusted principal. B) The rate is fixed but principal grew, so dollar coupon grows. C) TIPS aren't amortized as premium. D) The rate is fixed, not indexed.

$1,000 par bond, 6% coupon, trading at 95. Current yield equals:

1. 5.71% (60 / 1,050) — premium bond formula
2. 6.00% (coupon rate) — no price adjustment
3. 6.32% (60 / 950) — discount bond formula
4. 6.50% (65 / 1,000) — wrong coupon and price

Answer: C — 6.32% (60 / 950) — discount bond formula

A) That's a premium bond formula. B) Coupon rate isn't current yield when price ≠ par. C) Correct — CY = $60 / $950 ≈ 6.32%. D) Uses wrong coupon and price.

A Treasury STRIP is BEST described as a:

1. Callable Treasury bond with variable coupon
2. Coupon-paying agency mortgage security
3. Zero-coupon Treasury from separated cash flows
4. Short-term Treasury bill of 4-week maturity

Answer: C — Zero-coupon Treasury from separated cash flows

A) STRIPs are not callable and have no coupon. B) STRIPs are Treasury-only, not agency MBS. C) Correct — STRIPs are created by separating coupon and principal cash flows. D) Bills are a separate product.

Which bond has the greatest price volatility to interest rate changes?

1. Low coupon, long maturity
2. High coupon, long maturity
3. Low coupon, short maturity
4. High coupon, short maturity

Answer: A — Low coupon, long maturity

A) Correct — long maturity and low coupon maximize duration, producing the largest price swing. B) High coupon reduces duration. C) Short maturity reduces duration. D) Both high coupon and short maturity minimize sensitivity.

A 6% corporate bond trades at $1,050 with 10 years to maturity, non-callable. Which yield is LOWEST?

1. Coupon (nominal) yield
2. Current yield
3. Yield to maturity
4. All are equal on a premium bond

Answer: C — Yield to maturity

A) Coupon stays 6%, highest on a premium bond. B) Current yield = 60/1050 ≈ 5.71%. C) Correct — YTM accounts for amortization of premium and is the lowest. D) They differ on any premium bond.

A mortgage-backed security holder is MOST exposed to which risk when rates FALL?

1. Duration extension risk beyond stated maturity
2. Credit downgrade of the mortgage originator bank
3. Rising credit losses in the mortgage pool holdings
4. Prepayment risk as borrowers refinance mortgages

Answer: D — Prepayment risk as borrowers refinance mortgages

A) Extension risk arises when rates RISE. B) Originator credit is not the primary MBS driver. C) Credit losses come mainly with recession, not rate cuts. D) Correct — falling rates trigger refinancing, returning principal early at par.

An ADR holder is MOST exposed to which risk beyond a domestic U.S. shareholder?

1. Interest rate risk on the underlying equity
2. Systematic market risk of the U.S. equity market
3. Sector concentration risk within U.S. equities
4. Currency exchange risk versus the home currency

Answer: D — Currency exchange risk versus the home currency

A) Interest rate risk affects fixed-income primarily. B) All U.S. investors bear market risk equally. C) Sector risk is not unique to ADRs. D) Correct — ADRs bear FX risk on dividends and underlying value.

A bond is purchased at a discount to par. Which ranking of its yields is correct?

1. Nominal yield > Current yield > Yield to maturity
2. Yield to maturity > Current yield > Nominal yield
3. Current yield > Yield to maturity > Nominal yield
4. All three yields are always equal for a discount bond

Answer: B — Yield to maturity > Current yield > Nominal yield

B) Correct — for a discount bond, YTM is highest (captures price appreciation to par), then current yield, then nominal (coupon) yield lowest. A) This ranking applies to a PREMIUM bond, not a discount bond. C) Current yield does not exceed YTM on a discount bond. D) The three yields are equal only at par, not at a discount.

U.S. Treasury bills are best characterized as:

1. Long-term coupon-bearing federal bonds
2. Federally tax-exempt state municipal notes
3. Short-term federal debt sold at a discount
4. Corporate debt guaranteed by the Treasury

Answer: C — Short-term federal debt sold at a discount

A) Those are Treasury bonds/notes, not bills. B) T-bills are federal, not state, debt. C) Correct — T-bills have maturities of one year or less and are issued at a discount. D) T-bills are federal government debt, not corporate.

What is current yield?

Annual coupon ÷ Current market price. A $1,000 bond with 6% coupon at $900: $60/$900 = 6.67%.

A zero-coupon bond with 20 years to maturity is purchased at 40. Approximate YTM?

Approximately 4.7%. Using the rule of 72: 72 / 20 years ≈ 3.6%. More precisely, ($1,000/$400)^(1/20) − 1 ≈ 4.7%.

What is a convertible bond?

A corporate bond convertible into a predetermined number of common shares. Lower coupon due to conversion privilege.

For a discount bond, which yield is highest?

YTM > Current Yield > Coupon. For premium: Coupon > Current > YTM.