Remembering bond terminology

The Series 7 exam designers expect you to know general bond terminology. (And I give it to you here — that’s why I get paid the big bucks!) In this section, I help you reinforce the information you should have already learned from taking the Securities Industry Essentials exam. This stuff is basic, but the Series 7 exam does test it:

• Maturity date: All issued bonds have a stated maturity date (for example, 20 years, 30 years, and so on). The maturity date is the year bondholders get paid back for the loans they made. At maturity, bondholders receive par value (see the next bullet).

• Par value: Par value is the face value of the bond. Although par value isn’t significant to common stockholders (whose issuers use it solely for bookkeeping purposes), it’s important to bondholders. For Series 7 exam purposes, you can assume that the par value for each bond is $1,000 unless otherwise stated in the question.

  Bond prices are quoted as a percentage of par value, often without the percent sign. A bond trading at 100 is trading at 100 percent of $1,000 par. Regardless of whether investors purchase a bond for $850 (85), $1,000 (100), or $1,050 (105), they’ll receive par value at the maturity date of the bond, usually with interest payments along the way. Corporate bonds are usually quoted in increments of 1/8% (1/8% = 0.00125 or $1.25), so a corporate bond quoted at 993⁄8 (99.375%) would be trading at $993.75.

• Coupon rate: Of course, investors aren’t lending money to issuers for nothing; investors receive interest for providing loans to the issuer. The coupon rate on the bond tells the investors how much annual interest they’ll receive.

  The coupon rate is expressed as a percentage of par value. For example, a bond with a coupon rate of 6 percent would pay annual interest of $60 (6% × $1,000 par value). You can assume that bonds pay interest semiannually unless otherwise stated. So in this example, the investor would receive $30 every six months.

  Bondholders receive interest (payment for the use of the money loaned), and stockholders receive dividends (see Chapter 6).

• The bond indenture: The indenture (also known as deed of trust) is the legal agreement between the issuer and the investor. It’s printed on or attached to the bond certificate. All indentures contain basic terms:

  • The maturity date
  • The par value
  • The coupon rate (interest rate) and interest payment dates
  • Any collateral securing the bond (see “Comparing secured and unsecured bonds” later in this chapter)
  • Any callable or convertible features (check out “Contrasting callable and put bonds” and “Popping the top on convertible bonds” later in this chapter)

  The bond indenture also includes the name of a trustee. A trustee is an organization that administers a bond issue for an institution. It ensures that the bond issuer meets all the terms and conditions associated with the borrowing. Essentially, the trustee tries to make sure that the issuer does the right thing.

The following question tests your knowledge of bond interest.

Jane Q. Investor purchased 100 AA rated bonds issued by COW Corp. Jane purchased the bonds at 105 percent of par value, and they are currently trading in the market at 104. If the coupon rate is 7½ percent, how much annual interest does Jane receive?

(A) $37.50

(B) $75.00

(C) $3,750.00

(D) $7,500.00

The correct answer is Choice (D). This is a nice, easy question after you wade through the information that you don’t need. You need only the number of bonds and the coupon rate to figure out the answer. Don’t let yourself get distracted by the rating, purchase price, or market price. That information is there to confuse you.

Jane purchased 100 bonds at $1,000 par (remember you can assume $1,000 par) with a coupon rate of 7½ percent, so do the math:

Choice (C) would have been correct if the question had asked for the semiannual interest.

Comparing secured and unsecured bonds

The assets of the issuer may or may not back bonds. For test purposes, assume that bonds backed by collateral (assets that the issuer owns) are considered safer for the investor. Secured bonds, or bonds backed by collateral, involve a pledge from the issuer that a specific asset (for instance, property) will be sold to pay off the outstanding debt in the event of default. Obviously, with all else being equal, secured bonds normally have a lower yield than unsecured bonds.

The Series 7 tests your knowledge of several types of secured bonds:

• Mortgage bonds: These bonds are backed by property that the issuer owns. In the event of default or bankruptcy, the issuer must liquidate the property to pay off the outstanding bonds.
• Equipment trusts: This type of bond is mainly issued by transportation companies and is backed by equipment they own (for instance, airplanes or trucks). If the company defaults on its bonds, it sells the assets backing the bonds to satisfy the debt.
• Collateral trusts: These bonds are backed by financial assets (stocks and bonds) that the issuer owns. A trustee (a financial institution the issuer hires) holds the assets and sells them to pay off the bonds in the event of default.
• Guaranteed bonds: Guaranteed bonds are backed by a firm other than the original issuer, usually a parent company. If the issuer defaults, the parent company pays off the bonds.
• Unsecured bonds: The opposite of secured bonds, these bonds are not backed by any assets whatsoever, only by the good faith and credit of the issuer. If a reputable company that has been around for a long time issues the bonds, the bonds aren’t considered too risky. If they’re issued by a relatively new company or one with a bad credit rating, hold onto your seat! Again, for Series 7 exam purposes, assume that unsecured bonds are riskier than secured bonds. Here’s the lineup of unsecured bonds:
• Debentures: These bonds are backed only by the issuer’s good word and written agreement (the indenture) stating that the issuer will pay the investor interest when due (usually semiannually) and par value at maturity.
• Income bonds: These bonds are the riskiest of all. The issuer promises to pay par value back at maturity and will make interest payments only if earnings are high enough. Companies in the process of reorganization usually issue these bonds at a deep discount (for example, the bonds sell for $500 and mature at par, or $1,000). For test purposes (and real-world purposes), you shouldn’t recommend these bonds to investors who can’t afford to take a lot of risk.

Because secured bonds are considered safer than unsecured bonds, secured bonds normally have lower coupon rates. You can assume that for the Series 7, the more risk an investor takes, the more reward he will receive. Remember the saying “more risk equals more reward.” More reward may be in the form of a higher coupon rate or a lower purchase price. Either one — or both — lead to a higher yield for the investor.

Check out the following question for an example of how the Series 7 may test your knowledge of the types of bonds.

From the SIE Exam, the secured and unsecured bonds may be in book entry form (most likely), full registered, partially registered, or in bearer form. They can also be series bonds, serial bonds, or term bonds.

Additional bond types

The following bonds may be secured or unsecured, which would be stated in the bond indenture.

Finding bond yields

The following sections review the types of bond yields and how the Series 7 exam tests this topic.

Current yield

The current yield (CY) is the annual rate of return on a security. The CY of a bond changes when the market price changes; you can determine the CY by dividing the annual interest by the market price:

The following question involves bond yields.

Monique Moneybags purchased one XYZ convertible mortgage bond at 105. Two years later, the bond is trading at 98. If the coupon rate of the bond is 6%, what is the current yield of the bond?

(A) 5.7%

(B) 6.0%

(C) 6.1%

(D) Cannot be determined

The correct answer is Choice (C). Yes, I’m giving you a question with a lot of unnecessary information. All I can tell you is that, unfortunately, you’ll have to get used to it. The Series 7 exam creators are notorious for inserting useless (and sometimes misleading) information into the questions to daze and confuse you. In this case, you need only the annual interest and the market price to calculate the answer. Use the following formula to get your answer:

The annual interest is $60 (6% coupon rate × $1,000 par value), and the current market price is $980 (98% of $1,000 par). The facts that the bond is convertible (bondholders can trade it for common stock — see “Popping the top on convertible bonds” later in this chapter) or a mortgage bond (backed by the issuer’s property) and that it was purchased at 105 ($1,050) are irrelevant.

“Cannot be determined,” as tempting as it may be, is almost never the correct answer on the Series 7 exam.

Yield to maturity (basis)

The yield to maturity (YTM) is the yield an investor can expect if holding the bond until maturity. The YTM takes into account not only the market price but also par value, the coupon rate, and the amount of time until maturity. When someone yells to you, “Hey, what’s that bond yielding?” (all right, maybe I run in a different circle of friends), he’s asking for the YTM. The formula for YTM is as follows:

This formula can be difficult to remember. If you have it down, kudos (whatever that means) to you. It’s tested (although somewhat rarely) on the Series 7 exam, and you may be one of the unlucky blokes who need this formula. For more on accretion and amortization, please visit Chapter 15.

Discount yield

This is the yield on securities that are issued at a discount and don't make interest payments, such as T-bills. To calculate the discount yield, use the following formula:

Don't spend too much time working on the discount yield formula because even though it's in the FINRA outline, I think your chances of having to do calculations using the formula are pretty slim. The most important thing to remember is that T-bills are issued on a discount yield basis.

Using seesaw calculations for price and yields

In this section, I show you how to use a “seesaw” to help you better visualize the relationship between bond prices and yields. I know this method is a little goofy, but I’ll do anything (well, almost anything) to help you pass the Series 7 exam.

Higher numbers make the seesaw rise, and lower numbers make it fall. Looking at the following diagram, you can see that if a bond is at par, the seesaw remains level. If the prices decrease, the yields increase, and if the prices increase, the yields decrease. The center support (n) represents the nominal yield (coupon rate) of the bond because it remains constant no matter what happens to the prices or other yields. (Note: In the seesaw, NY stands for nominal yield, CY is current yield, YTM is yield to maturity, and YTC is yield to call.)

© John Wiley & Sons, Inc.

Check out the following problem and its explanation, which show you how to put the seesaw in motion.

Jonathan Bullinski purchased an 8 percent ABC bond yielding 9 percent. He purchased the bond at

(A) a discount

(B) par

(C) a premium

(D) a price that cannot be determined

The correct answer is Choice (A). The question states that the nominal yield is 8 percent and the bond is yielding 9 percent. The 9 percent is the yield to maturity:

© John Wiley & Sons, Inc.

Because the YTM is greater than the NY, the right side of the seesaw goes up and the left side of the seesaw goes down. This means that the investor paid a price that was at a discount (below par). You can also determine that the current yield (CY) would have to be between 8 and 9 percent and the yield to call (YTC) would have to be greater than 9 percent.

If the YTM were lower than the NY, the seesaw would tip the opposite way, and the price would be at a premium rather than at a discount.

Calculating accrued interest

When investors purchase bonds in the market, they may have to pay an additional cost besides the market price (and, of course, your commission). The additional cost is called accrued interest. Accrued interest, which is due when bonds are purchased between coupon dates, is the portion of the interest still due to the seller. As you may remember, bonds pay interest once every six months. If an investor holds onto a bond for five months out of a six-month period, he is entitled to 5/6 of that next interest payment; that’s accrued interest.

When taking the Series 7 exam, you need to be able to calculate the number of days of accrued interest that the buyer owes the seller. Although you can calculate the accrued interest with a few different methods, I’m here to make your life easier by showing you one of the simplest ways.

Accrued interest on corporate and municipal bonds is calculated on a 360-day year and assumes 30-day months. Accrued interest on U.S. government bonds is calculated using the actual days per year and the actual days per month.

The following sample question tests your ability to figure out this prorated amount.

Accrued interest is calculated from the previous coupon date up to, but not including, the settlement date.

Now you’re probably asking yourself, “What the heck does that mean?” I can show you a nice, easy way to calculate the answer. Using the preceding example, assume that the settlement date is October 25. You would write it as 10/25 (tenth month and 25th day). The previous coupon date would be 7/1 (July 1). You can now set up a subtraction problem:

• 10/25
• –7/1
• 3/24 (3 months × 30-day months) + 24 days = 114 days of accrued interest

First subtract the seventh month (July) from the tenth month (October). You end up with three months. Because corporate and municipal bonds calculate accrued interest using 30-day months, you have to multiply three months by 30 days to get an answer of 90 days. Subtract the previous coupon date (1) from the settlement date (25) to get an answer of 24 days. Add the 90 days and 24 days together, and you get 114 days as your answer.

Read carefully. To try to trip you up, the Series 7 exam writers may include the settlement date in the question. If this is the case, you don’t need to add days to the trade date.

You can use the same formula to calculate accrued interest on U.S. government securities. (For basic information, see “Exploring U.S. Government Securities” later in the chapter.) However, U.S. government securities settle in one business day, not two. Additionally, U.S. government securities are calculated using actual days per month. The following example shows you how to calculate interest for a U.S. government securities question.

Your 31-day months are January, March, May, July, August, October, and December. All the rest of the months have 30 days, except for February, which has 28. For February, you subtract two days. I know what you’re thinking: “What about leap year?” I haven’t heard of anyone getting a leap-year question yet, but if you’re that unlucky person, subtract only one day for February.

Most bonds pay interest every six months. However, occasionally the dated date (the first date the bonds start accruing interest) of the bonds doesn't line up exactly six months from the first coupon date. If the first coupon date is more than six months from the dated date, it's called a long coupon. And if it's less than six months, it's called a short coupon. For newly issued bonds, which haven't made an interest payment yet, accrued interest is calculated from the dated date (the first date a bond starts accruing interest) not the previous coupon date because there isn't one.

Considering bond credit ratings

The institutions that rate bonds are most interested in the likelihood of default (the likelihood that the interest and principal won’t be paid when due). For the Series 7 exam, you can assume that the higher the credit rating, the safer the bond and, therefore, the lower the yield.

The two main bond credit rating companies for corporate and municipal bonds are Moody’s and Standard & Poor’s (S&P). S&P ratings of BB and lower and Moody’s ratings of Ba and lower are considered junk bonds or high-yield bonds, which have a high likelihood of default, as Table 7-1 explains. (Another credit rating service, called Fitch, uses the same rating symbols as Standard & Poor’s.) Note: Different sources may show some slight variations in how S&P and Moody’s ratings compare; however, the relationships here are the most common.

As if these categories aren’t enough, S&P can break down each category even further by adding either a plus (+) or minus (–) sign after the letter category. The plus sign represents the high end of the category, and the minus sign designates the lower end of the category. If you see no plus or minus sign, the bond is in the middle of the category. Moody’s can further break down a category by adding a 1, 2, or 3. The number 1 is the highest ranking, 2 represents the middle, and 3 is the lowest. The top four ratings are considered investment grade, and the letters below that are considered junk bonds or high-yield bonds.

The rating company with the capital letters (S&P) uses all capital letters (AAA, AA, and so on). Additionally, S&P has an ampersand (&) between the “S” and the “P” in its name. Think of the ampersand as being like a plus sign to help you remember that S&P uses pluses and minuses within its categories.

Here’s a typical bond-ratings question.

Contrasting callable and put bonds

As you may know, bonds can be issued in callable and put forms. Your mission for the Series 7 exam is to know which is better for investors and when bonds are likely to be called or put.

• Callable bonds: A callable bond is a bond that the issuer has the right to buy back from investors at the price stated on the indenture (deed of trust). Callable bonds are riskier for investors because investors can’t control how long they can hold onto the bonds. To compensate for this risk, they’re usually issued with a higher coupon rate (more risk = more reward).

  Most callable bonds are issued with call protection. Call protection is the amount of time (usually several years) that an issuer has to wait before calling its bonds. Some callable bonds also have a call premium, which is an amount over par value that an issuer has to pay if calling its bonds in the year or years immediately following the expiration of the call protection.

  If there is a make whole call provision, it allows the issuer to call the bonds providing that the issuer makes a lump sum payment to investors that not only includes payment for the bond but also the present value of any future interest payments investors will miss because of the call.

  Another type of bond that can be callable is a step coupon bond. Also known as stepped coupon bonds or step-up coupon securities, step coupon bonds typically start at a low coupon rate, but the coupon rate increases at predetermined intervals, such as every five years. The issuer typically has the right to call the bonds at par value at the time the coupon rate is due to increase.

• Put bonds: Put bonds are better for investors. Put bonds allow the investor to “put” the bonds back (redeem them) to the issuer at any time at the price stated on the indenture. Because the investors have the control, put bonds are (of course) rarely issued. Because these bonds provide more flexibility to investors (who have an interest in the bond and stock prices), put bonds usually have a lower coupon rate.

There’s a direct correlation between interest rates and when bonds are called or put. Issuers call bonds when interest rates decrease; investors put bonds when interest rates increase. Check out the following question to see how this works.

You can assume for Series 7 exam purposes that if interest rates increase, bond yields increase.

Popping the top on convertible bonds

Bonds that are convertible into common stock are called convertible bonds. Convertible bonds are attractive to investors because investors have an interest in the bond price as well as the price of the underlying stock. The Series 7 exam tests your expertise on whether converting a bond makes sense for an investor. This determination requires you to calculate the parity price of the bond or stock.

Parity occurs when a convertible bond and its underlying stock (the stock it’s convertible into) are trading equally (that is, when a bond trading for $1,100 is convertible into $1,100 worth of stock).

When answering Series 7 exam questions relating to convertible bonds, you always need to get the conversion ratio (the number of shares that the bond is convertible into). Here’s the formula for the conversion ratio:

You can then use the conversion ratio to calculate the parity price:

parity price of the bond = market price of the stock × conversion ratio

Use the formula to answer the next example question.

Jane Q. Investor purchased a 6 percent DIM convertible bond. Her DIM bond is currently trading at 106, and the underlying stock is trading at 26. If the conversion price is 25, which of the following statements are TRUE?

1. The stock is trading above parity.
2. The stock is trading below parity.
3. Converting the bond would be profitable.
4. Converting the bond would not be profitable.

(A) I and III

(B) I and IV

(C) II and III

(D) II and IV

The right answer is Choice (D). You can cross out two answers right away. If the stock is trading above parity, converting is always profitable. And if the stock is trading below parity, converting isn’t profitable. Therefore, you can eliminate Choices (B) and (C) right away. You’ve just increased your odds of getting the question correct from 25 to 50 percent. To increase your odds from 50 to 100 percent, follow these equations:

Currently, the bond is trading for $1,060 (106 percent of $1,000 par) and is convertible into stock valued at $1,040 (the parity price of the bond). Because the value of the bond is greater than the converted value of the stock, the stock is trading below parity and converting wouldn’t be profitable.

Here’s another problem that involves parity price.

Victoria purchased a Spanko, Inc., convertible bond at 115 with a conversion ratio of 25. If the common stock for Spanko, Inc., is currently $48 per share, when should Victoria convert her bond?

(A) Right away

(B) When the common stock falls below $46 per share

(C) When the common stock increases to $50 per share

(D) Never, because bonds are safer investments than stocks

The answer you want is Choice (A). Always assume for test purposes that if the stock is trading above parity, the investor should convert. You don’t need to figure out the conversion ratio because it was already given in the question. Here’s how to solve the problem:

The bond is currently trading at $1,150 (115 percent of $1,000 par) and is convertible into $1,200 worth of stock. It certainly makes sense for the investor to convert at this point. Although you can try to make a point for Choice (C), it’s not correct. On the Series 7 exam, if the stock is above parity, convert the bond. Convertible bonds and the underlying stock always seek parity. Even though $50 per share would be better than $48, the bond would also increase in price, and the conversion may not end up being as profitable.

For the most part, investors will convert their bonds when the value of the convertible bond is trading at a price that is lower than the value of the stock it's convertible into. This is known as an arbitrage (taking advantage of a disparity in prices) situation. Sometimes companies force a conversion (called a forced conversion) by calling bonds at a price that’s less than parity. In this situation, converting is more advantageous for investors.

Understanding the types and characteristics of U.S. government securities

Table 7-2 gives you an overview of different types of U.S. government securities and their specifics. Memorize all the information in the following chart so you can ace U.S. government securities questions on the Series 7 exam.

T-bills are sold on a discount-yield basis where the bid is higher than the ask. Typically, you might see the bid and ask prices for a bond as 99.5–99.7, respectively. This means that a person is bidding $995 (99.5% of $1,000 par) to purchase the bond while another person is willing to sell the bond for $997 (99.7% of $1,000 par). However, for T-bills, you might see the bid and ask prices as 2.250–2.150 respectively. The reason that they are quoted like this is that the bidder is bidding for a yield of 2.250, which would represent a lower dollar price than the ask price of 2.150. So if you see the bid number higher than the ask number, it is likely a T-bill quote.

For the Series 7, remember that the interest received on U.S. government securities is exempt from state and local taxes. The interest received on municipal bonds is exempt from federal taxes (although I get into that a little more in the next chapter). Chapter 15 gives you the scoop on taxes.

The following question concerns various types of bonds and U.S. government securities.

When you see a question on the Series 7 exam about the best investment when planning for a future event (for instance, college), the right answer will most likely be either zero-coupon bonds or T-STRIPS.

In the tranches: Delving into packaged mortgages (CMOs)

Just when you thought you were going to get out of debt securities relatively unscathed, you have collateralized mortgage obligations (CMOs) thrown at you. CMOs are annoying little (or big) debt securities backed by pools of mortgages (GNMA/Ginnie Mae, FNMA/Fannie Mae, FHLMC/Freddie Mac). What makes matters worse is that you probably won’t sell one in your entire career. However, CMOs are asset-backed securities covered on the Series 7 exam, and you need to know the basics in order to answer these questions correctly.

CMOs don’t have a set maturity date and are subject to things called extension risk and prepayment risk. Take a look at these terms:

• Average life: The average amount of time until a mortgage is refinanced or paid off; for example, a 30-year mortgage may have an average life of 17 years
• Prepayment risk: The risk that a tranche (slice or portion) of the loan will be called sooner than expected due to decreasing interest rates; more people refinance when interest rates are low
• Extension risk: The risk that a tranche will be called later than expected due to a less-than-normal amount of refinancing; extension occurs when interest rates are high

CMOs are also broken down into tranches (slices) of varying maturity dates. The basic type of CMO has tranches that are paid in a specific sequence. All tranches receive regular interest payments, but only the tranche with the shortest maturity receives principal payments. After the shortest tranche is retired, the second-shortest receives principal payments until that tranche is retired, and then the principal is paid to the next tranche. This type of structure is known as a plain vanilla offering. The following list describes other types of CMO tranches:

• Planned amortization class (PAC) tranches: This type of CMO is the most common because it has the most certain prepayment date. The prepayment and extension risk can be somewhat negated by a companion tranche, which assumes a greater degree of the risk. Because of the relative safety of PAC tranches, they usually have the lowest yields.
• Targeted amortization class (TAC) tranches: This CMO is the second-safest. TAC tranche-holders have somewhat less-certain principal payments and are more subject to prepayment and extension risk. TAC tranches have yields that are low but not as low as those of PAC tranches.
• Companion tranches (support bonds): Companion tranches are included in every CMO that has PAC or TAC tranches. Companion tranches absorb prepayment risk associated with CMOs. The average life of a companion tranche varies greatly depending on interest rate fluctuations. Because more risk is associated with companion tranches, they have higher yields.
• Z-tranches (accrual bonds): Z-tranches are usually the last tranche (they have longest maturity) in a series of PAC or companion tranches. Z-tranches don’t receive interest or principal until all the other tranches in the series have been retired. The market value of Z-tranches can fluctuate widely. Z-tranches are somewhat similar to a zero-coupon bond (which is bought at a discount and does not receive interest along the way).
• Principal-only (PO) tranches: Principal-only tranches are purchased at a price deeply discounted below face value. Investors receive face value through regularly scheduled mortgage payments and prepayments. The market value of a PO increases if interest rates drop and prepayments increase.
• Interest-only (IO) tranches: All CMOs with principal-only tranches also have interest-only tranches. IOs are sold at a deep discount below their expected value based on the principal amount used to calculate the amount of interest due. Contrary to PO tranches, the market value of an IO increases if interest rates increase and prepayments decrease.
• Floating rate tranches: These tranches appear with CMOs in which the interest rates are tied to an interest rate index (for instance, London Interbank Offered Rate/LIBOR). Investors can use these investments to hedge interest rate risk on other investments.

Although I discuss several types of tranches, the most important ones on the Series 7 exam are the PAC, TAC, companion, and Z-tranches.

The following question tests your understanding of tranches.

I know that this information is a lot to take in and may be a little confusing. Remembering the basics can help you get most of the questions correct: PAC tranches are the safest; TAC tranches are the second safest; companion tranches support PAC and TAC tranches; and Z-tranches have the longest maturity.

Backed by debt: Collateralized debt obligations (CDOs)

Now that you’re a master of CMOs, I figure this is the point at which it makes the most sense to delve into collateralized debt securities (CDOs). The idea behind CDOs is quite similar to collateralized mortgage obligations because they’re also broken down into tranches representing differing amounts of risk and/or maturities. Obviously, as with other investments, the more risk, the more reward (or potential reward). The difference with CDOs is that instead of being backed by mortgages, they’re backed by a pool of bonds, loans, or other debt instruments. In the event of a shortfall of cash, holders of senior CDOs are paid first. I could break them down into classes for you, but fortunately, I think that would be more than you need to know for the Series 7 exam. Interest received from CDOs is taxable on all levels (federal, state, and local).

CDOs are not ideal investments for most investors. CDOs are complex and often difficult for average investors to understand. Therefore, they are more suitable for sophisticated or institutional investors.

SNK Surfboard Company wants to import boogie boards from an Italian manufacturer in Sicily. SNK would use which of the following money market instruments to finance the importing of the boogie boards?

(A) T-bills

(B) Collateral trust bonds

(C) Repurchase agreements

(D) Banker’s acceptances

The correct answer is Choice (D). You can eliminate Choice (B) right away because collateral trust bonds aren’t money market instruments; they’re secured long-term bonds. A banker’s acceptance is like a post-dated check that’s used specifically for importing and exporting goods.