Questions and Answers of Fixed Income Analysis

Explain how the asset swap spread is determined.
Explain how asset swap spreads are used as measures of relative value.
Describe in some detail how a credit default swap works. A diagram may prove useful.
Give some examples of a “credit event.”
If physical delivery of a credit default swap is required, what is meant by the “cheapest to deliver obligation.”
a. What is the linkage among asset swap spreads, CDS spreads, and credit spreads?b. What is the credit default swap basis and how is it used as a measure of relative value?
Explain why an “at market” interest rate swap can be described as buying and selling LIBOR.
What is meant by notional principal?
Why is the price quote of an interest rate swap in the form of a swap spread?
Give two interpretations of an interest rate swap and explain why an interest rate swap can be interpreted in each way.
Suppose that interest rates increase subsequent to the inception of an interest rate swap.a. What is the effect on the value of the swap from the perspective of the fixed rate payer?b. What is the
Explain why both sides of a swap contract are exposed to counterparty risk?
“The swap rate is the fixed rate that will make the present value of the fixed rate payments equal the present value of the floating rate payments.”Do you agree or disagree with this statement.
What are the primary drivers of the level of swap spreads?
What role do Eurodollar futures play in the valuation of a swap contract?
Using the information in the following table, construct an Excel spreadsheet to answer questions (a)–(d).Assume the frequency of both sides of the swap is quarterly and both use an actual/360 day
Using the information in the following table, construct an Excel spreadsheet to answer questions (a) and (b).Assume the frequency of both sides of the swap is quarterly and both use an actual/360 day
a. What is implied volatility?b. What are the problems associated with using implied volatility as a measure of yield volatility?
Explain why you agree or disagree with the following statement: Two portfolio managers with the same set of daily yields will compute the same historical annual yield volatility.
In forecasting yield volatility, why would an analyst not want to weight each daily yield change equally?
Using the data below, compute the daily standard deviation of the percentage change in yield using the daily yields for the 30-year Treasury CMT. 2008-10-06 3.99 2008-10-07 4.01 2008-10-08 4.09
For the daily yield volatility computed in Question 5, what is the annual yield volatility assuming the following number of trading days in the year: 250, 260 and 365.
What assumptions of the Black model make the interpretation of implied volatility problematic?
Explain what is meant by the “implied volatility smile.”
What is the logic behind the ARCH method for forecasting yield volatility?
Fred Derf found his lost passbook for a saving account that he had opened with a $100 deposit 12 years ago. If the bank paid interest at a rate of 5% compounded annually over this period, what should
You are planning to leave civilization to live in a heavily fortified bunker up in the mountains and be a survivalist in 10 years. You will be able to deposit $$1,000$ per year at the end of each
The grand prize for a lottery is $$1,000$ per year for 10 years and then $$500$ per year in perpetuity (i.e., the first $$500$ payment is at the end of year 11). If the relevant interest rate
What is the future value of $1,000 to be invested now for five years if the interest rate is 12% compoundeda. annually?b. semiannually?c. quarterly?d. monthly?
What is the present value of $1,000 to be received five years from now if the interest rate is 12% compoundeda. annually?b. semiannually?c. quarterly?d. monthly?
You are saving to retire with $$1$ million 30 years from today. You can start the savings plan with a $$5,000$ deposit today. Additionally, you can deposit $$7,500$ 10 years from today,
Suppose an investor is considering the purchase of a financial instrument that promises to deliver the following semiannual cash flows: four payments of $$40$ every six months for two years and
Consider a 4-year 8% coupon bond with a $1,000 maturity value.Assume the bond delivers coupon interest annually. What is the present value of the cash flows using the required interest rates shown
What semiannual interest rate is required to produce an effective annual yield of 7.4%?
Describe one application of the spot rate curve and one application of the forward rate curve.
Consider the following five hypothetical Treasury securities:What is the 2.5 year spot rate? Maturity Yield to Maturity Price 0.50 3.00 1.00 3.30 1.50 3.50 100 2.00 3.90 100 2.50 4.40 100
Suppose the following information (yields are quoted on a bond-equivalent basis) is available:6-month bill rate = 3.8%1-year bill rate = 4.2%What is the implied 6-month forward rate six months from
Suppose the following information is available:4-year spot rate = 6%7-year spot rate = 6.8%What is the implied forward rate on a 3-year zero coupon Treasury four years from now quoted on a
What is the relationship between par rates and spot rates when the yield curve is upward sloping/downward sloping?
What are the three types of yield curve changes? How are these changes related with one another?
What factors influence forward rates implied from the yield curve other than the market’s expectations of future interest rates?
a. Explain what is meant by the term structure of volatility.b. What is the most frequently observed shape of the term structure of volatility?
What complications arise when one values a bond on a settlement date between coupon payment dates?
Define the term “day count basis.”
Explain why the quoted yield on a bank discount basis for a U.S. Treasury bill is not directly comparable to a coupon Treasury’s yield?
Consider a 4.75% coupon, 10-year U.S. Treasury note that matures on August 15, 2017. Calculate the accrued interest for a $1 million par value position assuming a settlement date of October 16, 2007.
“The growth of accrued interest takes place independently of changes in the interest rate environment.” Do you agree or disagree with this statement? Explain your reasoning.
“The 30/360 day count convention will always result in a fewer number of days between dates than the Actual/Actual day count.” Do you agree or disagree with this statement? Explain your reasoning.
Does interest accrue for a Treasury note or bond accrue at the same rate every semiannual coupon period?
Consider a 7.25% coupon, Fannie corporate bond that matures on May 15, 2030. Calculate the accrued interest for $1 million par value position assuming a settlement date of October 16, 2007. The last
If yields are unchanged, explain why the price of a coupon bond selling at a discount increases as its maturity date approaches.
If yields are unchanged, explain why the price of a coupon bond selling at a premium decreases as its maturity date approaches.
Suppose that a U.S. Treasury note maturing August 15, 2009 is purchased with a settlement date of July 31, 2007. The coupon rate is 3% and the maturity value of the position is $1,000,000. The next
What factors cause a bond’s price to change?
Why should a coupon paying bond be viewed as a portfolio of zerocoupon bonds?
What path does a par bond’s flat price take between coupon payment dates if the discount rate is unchanged?
What is relationship between an option-free bond’s price and its yield?What is the import of this shape to bondholders?
What process assures that the market price of a Treasury security will not differ materially from the arbitrage-free value?
An investor is considering the purchase of a 20-year, 7% coupon bond selling for $$815.984$ and a par value of $$1,000.$ The yield to maturity is 9%.a. What would be the total future dollars
Under what assumptions is the yield to maturity a reasonable estimate of the potential return of holding a bond?
Under what assumptions is the yield to call a reasonable estimate of the potential return of holding a callable bond?
Explain what is meant by yield to worst?
What are the sources of return that any yield measure should incorporate?
Consider the following hypothetical spot curve to two years:Use these spot rates to price a 4% coupon, 2-year notes and answer the following questions.a. What is the yield to maturity of the note?b.
What are the relationships among coupon rate, current yield and yield to maturity for a premium, discount and par bond?
Suppose a 6-month Treasury bill is priced with a yield on a bank discount basis of 3.31%. The bill will mature in 181 days.a. Assume the face value is $1,000, what is the bill’s dollar price?b.
How does the Z-spread differ from the nominal spread?
What are the drawbacks of using discounted margin to evaluate a floating rate security?
What is the basic coupon rate formula for an option-free floater and explain each component of the formula?
What is the relative exposure to interest rate risk of a floater versus an inverse floater?
The coupon formula for an inverse floater whose reference rate is 6-month LIBOR is as follows:If 6-month LIBOR changes by 100 basis points, then what is the impact on the coupon rate for the inverse
What is meant by a cap and floor?
What is the impact on interest rate risk of including a cap and/or floor in the coupon structure?
Explain how an “index amortizing note” works?
The pricing expression for a risky floater can be thought of as possessing two components. Explain.
Explain whether you agree or disagree with the following statement: “A floater whose quoted margin equals the market’s required margin trades at par regardless of the path the reference rate
Consider a floater whose coupon formula is 3-month LIBOR plus 45 basis points and delivers coupon payments quarterly. The flat price of the floater is 99.99 and the floater has 345 days until
Consider the following floater:Maturity= 6 years Coupon rate = reference rate plus 80 basis point resets every six months Maturity value = $$100$ Market price = $$99.1381$ Reference rate =
A “buy-and-hold” investor purchases a 10-year, 8% annual coupon payment bond at 85.503075 per 100 of par value and holds it until maturity. The investor receives the series of 10 coupon payments
The investment manager for a UK defined-benefit pension scheme is considering two bonds about to be issued by a large life insurance company. The first is a 30-year, 4% semiannual coupon payment
The second investor buys the 10-year, 8% annual payment bond at 85.503075 and sells it in four years. After the bond is purchased, interest rates go up to 11.40%. The future value of the reinvested
A second investor buys the 10-year, 8% annual coupon payment bond and sells the bond after four years. Assuming that the coupon payments are reinvested at 10.40% for four years, the future value of
The buy-and-hold investor purchases the 10-year, 8% annual payment bond at 85.503075. After the bond is purchased and before the first coupon is received, interest rates go up to 11.40%. The future
The buy-and-hold investor purchases the 10-year bond at 85.503075 and holds the security until it matures. After the bond is purchased and before the first coupon is received, interest rates go down
The second investor buys the 10-year bond at 85.503075 and sells it in four years. After the bond is purchased, interest rates go down to 9.40%. The future value of the reinvested coupons at 9.40% is
An investor buys a four-year, 10% annual coupon payment bond priced to yield 5.00%. The investor plans to sell the bond in two years once the second coupon payment is received. Calculate the purchase
Defined-benefit pension schemes typically pay retirees a monthly amount based on their wage level at the time of retirement. The amount could be fixed in nominal terms or indexed to inflation. These
Assume that the 3.75% US Treasury bond that matures on 15 August 2041 is priced to yield 5.14% for settlement on 15 October 2020. Coupons are paid semiannually on 15 February and 15 August. The
A hedge fund specializes in investments in emerging market sovereign debt. The fund manager believes that the implied default probabilities are too high, which means that the bonds are viewed as
An investment fund owns the following portfolio of three fixed-rate government bonds:The total market value of the portfolio is EUR96,437,017. Each bond is on a coupon date so that there is no
A life insurance company holds a USD10 million (par value) position in a 5.95% Dominican Republic bond that matures on 25 January 2027. The bond is priced (flat) at 101.996 per 100 of par value to
A Dutch bank holds a large position in a zero-coupon Federal Republic of Germany government bond maturing on 11 April 2025. The yield-to-maturity is −0.72% for settlement on 11 May 2020, stated as
An investor plans to retire in 10 years. As part of the retirement portfolio, the investor buys a newly issued, 12-year, 8% annual coupon payment bond. The bond is purchased at par value, so its
A hedge fund specializes in investments in emerging market sovereign debt. The fund manager believes that the implied default probabilities are too high, which means that the bonds are viewed as
Which of the following sources of return is most likely exposed to interest rate risk for an investor of a fixed-rate bond who holds the bond until maturity?A. Capital gain or lossB. Redemption of
An investment fund owns the following portfolio of three fixed-rate government bonds:The total market value of the portfolio is EUR96,437,017. Each bond is on a coupon date so that there is no
A life insurance company holds a USD10 million (par value) position in a 5.95% Dominican Republic bond that matures on 25 January 2027. The bond is priced (flat) at 101.996 per 100 of par value to
A Dutch bank holds a large position in a zero-coupon Federal Republic of Germany government bond maturing on 11 April 2025. The yield-to-maturity is −0.72% for settlement on 11 May 2020, stated as
An investor plans to retire in 10 years. As part of the retirement portfolio, the investor buys a newly issued, 12-year, 8% annual coupon payment bond. The bond is purchased at par value, so its
An investor purchases a bond at a price above par value. Two years later, the investor sells the bond. The resulting capital gain or loss is measured by comparing the price at which the bond is sold

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