A broker advised his client who is concerned about maintaining principal to invest in treasury bonds because the principal is ‘guaranteed by the US government’. Did the broker violate the Standard on misrepresentation? I chose c) “Yes, because the broker misrepresented the characteristics of an investment”. The correct answer as a) “No, the statement the broker made was accurate”. My rationale for choosing c) is that, although Treasury bonds are backed by the full faith of the US government, the premium paid on a bond will not be recovered if held to maturity (e.g. pay $105, receive $100 face value at maturity). Comments?
The coupons are guaranteed by the govt as well and the coupon payments represent return of principal (that was excellent sounding bs).
Why are the coupons considered principal and not interest?
The reason that you are paying 105 for the bond is that the coupon interest is higher than the market interest rate (probably). Thus, if you held this bond to maturity you would be getting “extra” interest in each coupon payment. This “extra” interest represents return of capital from the original 105 amortized over the course of the bond. Of course, if the bond was at 105 because it was on special repo or the CTD on the futures contract in a bond squeeze or something then this wouldn’t be true and I would say answer C) might be true.