NASAA Series 66 Uniform Combined State Law ExaminationInvestment Vehicle CharacteristicsMedium
A client is looking to invest in a security that provides a fixed income stream and a return of principal at maturity. They are concerned about the financial stability of the issuing corporation but want to prioritize a higher yield than typically offered by government bonds. Which of the following debt securities would best fit these criteria, while acknowledging the credit risk?
- AMortgage-Backed Security (MBS)
- BTreasury Bond
- CCorporate Bond
- DMunicipal Bond
Show answer & explanationAnswer & explanation
Correct answer: C. Corporate Bond
Corporate bonds offer a fixed income stream and return of principal at maturity. They typically offer higher yields than Treasury bonds due to their inherent corporate credit risk, which aligns with the client's willingness to accept some credit risk for a higher yield while being concerned about the issuer's stability.
Why the other options are wrong
- A. MBS are subject to prepayment risk and are backed by mortgages, not directly by a corporate issuer's general credit, which is implied by 'financial stability of the issuing corporation'.
- B. Treasury bonds have virtually no credit risk and thus offer lower yields, not meeting the 'higher yield' criterion.
- D. Municipal bonds often offer tax-exempt interest, which isn't specified as a priority, and their yields can vary.
Corporate Bond
A debt instrument issued by a corporation to raise capital, typically offering a fixed interest payment and a promise to return the principal at maturity.
- Issued by corporations
- Fixed interest payments (coupon)
- Return of principal at maturity
- Subject to credit risk of the issuer
- Higher yields than government bonds (due to credit risk)
Memory trick: Debt securities are promises to pay, from 'T'reasuries to 'C'orporations.