SIE Products and Their Risks Practice Questions
Question 1
In a 401(k) plan, which of the following is generally true regarding vesting?
- A. Both employee and employer contributions are subject to the same vesting schedule
- B. Employee salary deferrals are always immediately 100% vested; employer matching contributions may be subject to a vesting schedule
- C. Employer contributions are always immediately vested, while employee deferrals vest over time
- D. Vesting schedules apply only to Roth 401(k) contributions, not traditional pre-tax 401(k) contributions
Show answer and explanation
Correct answer: B. Employee salary deferrals are always immediately 100% vested; employer matching contributions may be subject to a vesting schedule
An employee's own salary deferral contributions to a 401(k) are always immediately and fully vested, since it is the employee's own money. Employer matching or profit-sharing contributions, however, may be subject to a graded or cliff vesting schedule, meaning the employee must work a certain number of years before gaining full ownership of those employer-provided funds.
- A. Employee salary deferrals are always immediately vested; only employer contributions may carry a vesting schedule, so the two are not treated identically.
- B. Correct. An employee's own salary deferrals are always 100% vested immediately, while employer matching/profit-sharing contributions can be subject to a graded or cliff vesting schedule.
- C. This reverses the rule — it is the employee's own deferrals that vest immediately, while employer contributions may vest over time.
- D. Vesting schedules relate to the source of the contribution (employee vs. employer), not to whether the plan is Roth or traditional pre-tax.
Question 2
An investor buys a callable bond at a premium. For a premium callable bond, the yield to worst is generally:
- A. the yield to the earliest call date, which is lower than the yield to maturity.
- B. the yield to maturity, because premium bonds are normally held until they mature.
- C. the current yield, since it is the lowest yield measure for premium bonds.
- D. the nominal yield, equal to the coupon rate stated on the bond.
Show answer and explanation
Correct answer: A. the yield to the earliest call date, which is lower than the yield to maturity.
Yield to worst is the lowest yield from any possible call or maturity date. For a premium bond the ranking runs from nominal yield to current yield to yield to maturity to yield to call, so yield to call is the worst.
- A. Right: for a bond bought at a premium, being called early reduces the return, so yield to call is the lowest.
- B. For a premium bond, yield to call is lower than yield to maturity, so maturity is not the worst case.
- C. Current yield exceeds yield to maturity for a premium bond, so it is not the lowest.
- D. For a premium bond the nominal yield is the highest of the yields, not the lowest.
Question 3
A convertible bond gives the holder the right to:
- A. Redeem the bond early at par value at any time
- B. Exchange the bond for a predetermined number of shares of the issuer's common stock
- C. Receive a variable interest rate tied to a benchmark index
- D. Vote on matters at the issuer's annual shareholder meeting
Show answer and explanation
Correct answer: B. Exchange the bond for a predetermined number of shares of the issuer's common stock
The defining feature of a convertible bond is the option to convert it into a fixed number of the issuer's common shares. It does not grant early redemption at will, a floating rate, or voting rights while held as a bond.
- A. Incorrect. Early redemption at par at the issuer's option describes a call feature, not conversion, which is a right held by the bondholder.
- B. Correct. Convertibility gives the bondholder the option to exchange the bond for a fixed number of the issuer's common shares.
- C. Incorrect. A variable rate tied to a benchmark describes a floating-rate note, not the conversion feature of a convertible bond.
- D. Incorrect. Bondholders are creditors, not shareholders, and do not vote at shareholder meetings, whether or not the bond is convertible.
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All else being equal, which of the following bonds would experience the greatest percentage change in market price for a given change in interest rates?
- A. A 2-year bond with a 6% coupon
- B. A 30-year zero-coupon bond
- C. A 5-year bond with a 5% coupon
- D. A 1-year Treasury bill
Show answer and explanation
Correct answer: B. A 30-year zero-coupon bond
A bond's price sensitivity to interest rate changes (duration) increases with longer maturity and decreases as coupon rate increases (since higher coupons return cash flow sooner). A long-term zero-coupon bond has both the longest maturity and the lowest possible coupon (zero), giving it the highest duration and therefore the greatest price volatility for a given rate change.
- A. Wrong - short maturity and a relatively high coupon both reduce interest rate sensitivity.
- B. Correct - long maturity plus zero coupon maximizes duration and price sensitivity.
- C. Wrong - moderate maturity and coupon give it middling sensitivity, less than the zero-coupon long bond.
- D. Wrong - a 1-year T-bill has minimal duration and is the least interest-rate sensitive of the choices.