General Securities Representative (Series 7) Practice Exam

What does bond insurance primarily cover?

1. Loss of principal only

2. Loss of interest and principal prior to maturity

3. Default probability adjustments

4. Market price fluctuations

The correct answer is: Loss of interest and principal prior to maturity

Bond insurance primarily provides coverage for loss of interest and principal prior to maturity. This type of insurance is designed to protect bondholders in the event that the issuer of the bond defaults, thereby failing to make the required interest payments or repay the principal at maturity. When a bond is insured, the insurance company guarantees that the bondholder will receive payments owed, which effectively lowers the risk associated with investing in that bond. This protection is particularly valuable for investors who seek to mitigate the credit risk of the bond issuer, ensuring they can recoup their investment even if the issuer faces financial difficulties. As a result of this coverage, insured bonds generally have a lower default risk, which can lead to better pricing and higher demand in the market. In contrast, options that refer only to the loss of principal or adjustments for default probabilities do not accurately reflect the full scope of bond insurance. Market price fluctuations are also unrelated, as bond insurance does not cover changes in the market value of a bond due to interest rate movements or other market conditions. The focus of bond insurance is fundamentally on guaranteeing payment obligations, which ties back directly to coverage for loss of interest and principal before maturity.