Series 7 Exam Question 161: Answer and Explanation

Question: 161

If a bond's YTM is 6 percent, which of the following would MOST likely be refunded by the issuer?

I. Coupon 6½ percent, maturing in 2040, callable in 2030 at 104

II. Coupon 5½ percent, maturing in 2040, callable in 2029 at 104

III. Coupon 5½ percent, maturing in 2040, callable in 2029 at 100

IV. Coupon 6½ percent, maturing in 2040, callable in 2030 at 100

• A. I and II
• B. II and IV
• C. II only
• D. IV only

Correct Answer: D

Explanation:

D. You have to remember to look at this question from a corporation's point of view. As a practical matter, the issuer will most likely refund the issue that will cost it the most money over the life of the issue. The first thing that an issuer would look at is the coupon rate (highest coupon first), next would be the call premium (lowest call premium first), after that, the call date (earliest call date first), and last, the maturity (longest maturity first). Following this formula leads you to Choice (D).