Investment Products & Financial Instruments Flashcards

An investor in a 35% tax bracket receives $1,000 in qualified dividends from a stock investment. Assuming the qualified dividend tax rate is 15%, what is their after-tax income from these dividends?

Answer: $850

Qualified dividends are taxed at preferential rates (15% for this investor), so after-tax income = $1,000 × (1 - 0.15) = $850.

A collateralized mortgage obligation (CMO) differs from a standard mortgage-backed security (MBS) primarily because CMOs:

Answer: Divide mortgage cash flows into tranches with different prepayment risk and maturities

CMOs restructure mortgage cash flows into tranches with varying priorities for receiving principal payments, allowing investors to choose tranches matching their prepayment risk tolerance and maturity preferences.

Which of the following instruments would provide an investor with the MOST protection against rising interest rates?

Answer: A floating-rate note (FRN) tied to SOFR

Floating-rate notes reset their coupon payments periodically based on a benchmark rate like SOFR, so as interest rates rise, the coupon increases, maintaining the note's value near par.

A hedge fund uses a long/short equity strategy. This strategy involves:

Answer: Buying stocks expected to rise and short-selling stocks expected to fall

A long/short equity strategy simultaneously buys stocks expected to outperform (long positions) and short-sells stocks expected to underperform, aiming to profit from relative price movements.

Which statement about preferred stock is MOST accurate?

Answer: Preferred stock dividends must be paid before common stock dividends, and cumulative preferred stocks accumulate unpaid dividends

Preferred stockholders receive dividends before common stockholders, and cumulative preferred stock requires all missed dividends to be paid in arrears before common dividends can be distributed.

A currency forward contract differs from a currency futures contract primarily in that forwards are:

Answer: Customized OTC contracts with flexible terms and no daily mark-to-market

Currency forwards are over-the-counter instruments customized between counterparties with flexible amounts, dates, and settlement terms, unlike standardized exchange-traded futures with daily mark-to-market.

What is the primary purpose of a sinking fund provision in a corporate bond indenture?

Answer: To require the issuer to periodically retire a portion of the outstanding bond issue, reducing default risk

A sinking fund provision requires the issuer to retire portions of the bond issue over time through repurchases or lottery calls, reducing the outstanding principal and lowering default risk for remaining bondholders.