Series 7 Corporate Debt Securities Practice Questions
Question 1
In a corporate liquidation, which of the following debt holders has the LOWEST priority claim on the issuer's assets?
- A. Holders of first mortgage bonds
- B. General creditors holding unsecured debentures
- C. Holders of subordinated debentures
- D. Holders of secured equipment trust certificates
Show answer and explanation
Correct answer: C. Holders of subordinated debentures
Subordinated debenture holders contractually agree to be paid after senior (general) unsecured creditors are satisfied, placing them below secured bondholders (first mortgage bonds, equipment trust certificates) and below senior debenture holders in the liquidation priority. Only equity holders (preferred, then common) rank lower.
- A. First mortgage bonds are secured by specific collateral and rank among the highest-priority debt claims, not the lowest.
- B. General unsecured debentures rank ahead of subordinated debentures in a liquidation, so they are not the lowest-priority debt.
- C. Correct. Subordinated debentures are explicitly junior to other unsecured (general) creditors by contract, giving them the lowest priority claim among debt holders.
- D. Secured equipment trust certificates are backed by specific collateral (equipment) and rank among the highest-priority claims, not the lowest.
Question 2
A convertible bond has a conversion price of $25 per share and is currently trading in the market at $1,200. What is the parity price of the common stock?
- A. $30.00
- B. $25.00
- C. $40.00
- D. $48.00
Show answer and explanation
Correct answer: A. $30.00
The conversion ratio equals par value divided by conversion price: $1,000 / $25 = 40 shares. Parity price of the stock equals the bond's market price divided by the conversion ratio: $1,200 / 40 = $30. At parity, the bond and the equivalent number of shares are worth the same amount.
- A. Correct: $1,200 bond price ÷ 40-share conversion ratio = $30 parity price.
- B. This is simply the conversion price itself, not the parity price of the stock.
- C. This is the conversion ratio (40 shares), not a dollar price.
- D. This results from dividing the bond's market price ($1,200) directly by the conversion price ($25) instead of by the conversion ratio.
Question 3
A corporate bond with a $1,000 par value is quoted at 95. What is the current dollar price of the bond?
- A. $95.00
- B. $1,095.00
- C. $9,500.00
- D. $950.00
Show answer and explanation
Correct answer: D. $950.00
Corporate bond quotes are stated as a percentage of par (face) value, which is normally $1,000. A quote of 95 means 95% of $1,000, or $950. Candidates must convert bond quotes to dollars by multiplying the quoted percentage by the par value.
- A. Treats the quote as a literal dollar amount rather than a percentage of the $1,000 par value.
- B. Incorrectly adds the quote number to par instead of computing a percentage of par.
- C. Incorrectly multiplies as if the quote were 950% of par.
- D. Correct. 95% of $1,000 par = $950.
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An investor owns a 10-year, 4% corporate bond with a put provision that lets the holder sell it back to the issuer at par on any interest date after year 3. In year 5, comparable new bonds yield 7% and the investor's bond trades at 88. What is the most advantageous action?
- A. Hold the bond, because the put gives the issuer the right to retire it at par if rates keep rising, forcing the investor to reinvest.
- B. Sell in the market at 88, because the put price resets to the market price on the exercise date.
- C. Exercise the put at par, collecting more than the market price and reinvesting at the higher current yields.
- D. Hold to maturity, because exercising the put would forfeit the coupon interest accrued to date.
Show answer and explanation
Correct answer: C. Exercise the put at par, collecting more than the market price and reinvesting at the higher current yields.
A put provision gives the bondholder, not the issuer, the right to sell the bond back at a stated price, usually par. With market yields above the coupon, the bond trades below par, so exercising the put turns an 88 market value into 100 that can be reinvested at higher yields.
- A. This reverses the parties; a call, not a put, is the issuer's right to retire the bond, and the put belongs to the holder.
- B. The put price is fixed in the indenture, usually at par, and does not reset to the market price.
- C. Correct. The holder receives par instead of 88 and can reinvest at 7%.
- D. Accrued interest is paid with the redemption, so nothing is forfeited by exercising the put.