Questions and Answers of Fixed Income Analysis

An investment manager is considering decreasing portfolio duration versus a benchmark index given her expectations of an upward parallel shift in the yield curve. If she has a choice between a
An active fixed-income manager holds a portfolio of commercial and residential mortgage-backed securities that tracks the Bloomberg Barclays US Mortgage-Backed Securities Index. Which of the
An active fund trader seeks to capitalize on an expected steepening of the current upward- sloping yield curve using option-based fixed-income instruments. Which of the following portfolio
An active investor enters a duration-neutral yield curve flattening trade that combines 2-year and 10-year Treasury positions. Under which of the following yield curve scenarios would you expect the
Which of the following is the best measure of credit risk?A. The expected lossB. The severity of lossC. The probability of default
In the event of bankruptcy, claims at the same level of the capital structure are:A. On an equal footing, regardless of size, maturity, or time outstanding.B. Paid in the order of maturity from
Using both Moody’s and S&P ratings, which of the following pairs of ratings is considered high yield, also known as “below investment grade,” “speculative grade,” or “junk”?A.
Heavily regulated monopoly companies, such as utilities, often carry high debt loads. Which of the following statements about such companies is most accurate?A. Regulators require them to carry high
Why should credit analysts be concerned if a company’s stock trades below book value?A. It means the company is probably going bankrupt.B. It means the company will probably incur lots of debt to
Hexion Inc. is a specialty chemical company. It has a complicated, high-yield debt structure, consisting of first lien debt (loans and bonds), secured bonds, second lien bonds, and senior unsecured
Exhibit 21 shows several key sovereign statistics for Portugal.Based on those calculations, as well as other data from Exhibit 21, what can you say about Portugal’s credit trend? EXHIBIT 21 Key
If investors become increasingly worried about the economy—say, as shown by declining stock prices—what is the most likely impact on credit spreads?A. There will be no change to credit spreads.
Stedsmart Ltd and Fignermo Ltd are alike with respect to financial and operating characteristics, except that Stedsmart Ltd has less publicly traded debt outstanding than Fignermo Ltd. Stedsmart Ltd
Which of the following is not credit or credit-related risk?A. Default riskB. Interest rate riskC. Downgrade or credit migration risk
What is the difference between an issuer rating and an issue rating?A. The issuer rating applies to all of an issuer’s bonds, whereas the issue rating considers a bond’s seniority ranking.B. The
XYZ Corp. manufactures a commodity product in a highly competitive industry in which no company has significant market share and where there are low barriers to entry. Which of the following best
If management is of questionable character, how can investors incorporate this assessment into their credit analysis and investment decisions?A. They can choose not to invest based on the increased
In the event of default, the recovery rate of which of the following bonds would most likely be the highest?A. First mortgage debtB. Senior unsecured debtC. Junior subordinate debt
Based on the practice of notching by the rating agencies, a subordinated bond from a company with an issuer rating of BB would likely carry what rating?A. B+B. BBC. BBB−
During bankruptcy proceedings of a firm, the priority of claims was not strictly adhered to. Which of the following is the least likely explanation for this outcome?A. Senior creditors compromised.B.
The fixed-income portfolio manager you work with asked you why a bond from an issuer you cover didn’t rise in price when it was upgraded by Fitch from B+ to BB. Which of the following is the most
A fixed-income analyst is least likely to conduct an independent analysis of credit risk because credit rating agencies:A. May at times mis-rate issues.B. Often lag the market in pricing credit
Amalgamated Corp. and Widget Corp. each have bonds outstanding with similar coupons and maturity dates. Both bonds are rated B2, B−, and B by Moody’s, S&P, and Fitch, respectively. The bonds,
If goodwill makes up a large percentage of a company’s total assets, this most likely indicates that:A. The company has low free cash flow before dividends.B. There is a low likelihood that the
In order to analyze the collateral of a company, a credit analyst should assess the:A. Cash flows of the company.B. Soundness of management’s strategy.C. Value of the company’s assets in relation
In order to determine the capacity of a company, it would be most appropriate to analyze the:A. Company’s strategy.B. Growth prospects of the industry.C. Aggressiveness of the company’s
Based on the information provided in Exhibit 1, the EBITDA interest coverage ratio of Adidas AG is closest to:A. 16.02x.B. 23.34x.C. 37.98x. EXHIBIT 1 Adidas AG Excerpt from Consolidated
A credit analyst is evaluating the credit worthiness of three companies: a construction company, a travel and tourism company, and a beverage company. Both the construction and travel and tourism
The following information is from the annual report of Adidas AG for December 2019:• Depreciation and amortization: €1,214 million• Total assets: €20,640 million• Total debt: €4,364
Based on the information in Exhibit 2, GZ Group’s (a hypothetical company) credit risk is most likely:A. Lower than the industry.B. Higher than the industry.C. The same as the industry. EXHIBIT 2
Based on the information in Exhibit 3, the credit rating of DCM Group (a hypothetical company in the European food & beverage sector) is most likely:A. Lower than AB plc.B. Higher than AB plc.C.
Funds from operations (FFO) of Pay Handle Ltd (a fictitious company) increased in 20X1. In 20X1, the total debt of the company remained unchanged while additional common shares were issued. Pay
Holding all other factors constant, the most likely effect of low demand and heavy new issue supply on bond yield spreads is that yield spreads will:A. Widen.B. Tighten.C. Not be affected.
Credit risk of a corporate bond is best described as the:A. Risk that an issuer’s creditworthiness deteriorates.B. Probability that the issuer fails to make full and timely payments.C. Risk of loss
The risk that the price at which investors can actually transact differs from the quoted price in the market is called:A. Spread risk.B. Credit migration risk.C. Market liquidity risk.
Loss severity is best described as the:A. Default probability multiplied by the loss given default.B. Portion of a bond’s value recovered by bondholders in the event of default.C. Portion of a
The two components of credit risk are default probability and:A. Spread risk.B. Loss severity.C. Market liquidity risk.
For a high-quality debt issuer with a large amount of publicly traded debt, bond investors tend to devote most effort to assessing the issuer’s:A. Default risk.B. Loss severity.C. Market liquidity
The expected loss for a given debt instrument is estimated as the product of default probability and:A. (1 + Recovery rate).B. (1 − Recovery rate).C. 1/(1 + Recovery rate).
The priority of claims for senior subordinated debt is:A.Lower than for senior unsecured debt.B. The same as for senior unsecured debt.C. Higher than for senior unsecured debt.
A senior unsecured credit instrument holds a higher priority of claims than one ranked as:A. Mortgage debt.B. Second lien loan.C. Senior subordinated.
In a bankruptcy proceeding, when the absolute priority of claims is enforced:A. Senior subordinated creditors rank above second lien holders.B. Preferred equity shareholders rank above unsecured
In the event of default, which of the following is most likely to have the highest recovery rate?A. Second lienB. Senior unsecuredC. Senior subordinated
The process of moving credit ratings of different issues up or down from the issuer rating in response to different payment priorities is best described as: A. Notching.B. Structural
The factor considered by rating agencies when a corporation has debt at both its parent holding company and operating subsidiaries is best referred to as:A. Credit migration risk.B. Corporate family
Which type of security is most likely to have the same rating as the issuer?A. Preferred stockB. Senior secured bondC. Senior unsecured bond
Which of the following corporate debt instruments has the highest seniority ranking?A. Second lienB. Senior unsecuredC. Senior subordinated
An issuer credit rating usually applies to a company’s:A. Secured debt.B. Subordinated debt.C. Senior unsecured debt.
The rating agency process whereby the credit ratings on issues are moved up or down from the issuer rating best describes:A. Notching.B. Pari passu ranking.C. Cross-default provisions.
The notching adjustment for corporate bonds rated Aa2/AA is most likely:A. Larger than the notching adjustment for corporate bonds rated B2/B.B. The same as the notching adjustment for corporate
Which of the following statements about credit ratings is most accurate?A. Credit ratings can migrate over time.B. Changes in bond credit ratings precede changes in bond prices.C. Credit ratings are
Which industry characteristic most likely has a positive effect on a company’s ability to service debt?A. Low barriers to entry in the industryB. High number of suppliers to the industryC. Broadly
When determining the capacity of a borrower to service debt, a credit analyst should begin with an examination of:A. Industry structure.B. Industry fundamentals.C. Company fundamentals.
Based on Exhibits 5−7, in comparison to Company X, Company Y has a higher:A. Debt/capital.B. Debt/EBITDA.C. Free cash flow after dividends/debt.The following information relates EXHIBIT 5
Which of the following accounting issues should mostly likely be considered a character warning flag in credit analysis?A. Expensing items immediatelyB. Changing auditors infrequentlyC. Significant
Based on Exhibits 5−7, in comparison to Company Y, Company X has greater:A. Leverage.B. Interest coverage.C. Operating profit margin.The following information relates EXHIBIT 5 Consolidated Income
In credit analysis, capacity is best described as the:A. Quality of management.B. Ability of the borrower to make its debt payments on time.C. Quality and value of the assets supporting an issuer’s
Based on only the leverage ratios in Exhibit 4, the company with the highest credit risk is:A. Company A.B. Company B.C. Company C.The following information relates EXHIBIT 4 Industrial Comparative
Among the four Cs of credit analysis, the recognition of revenue prematurely most likely reflects a company’s:A. Character.B. Covenants.C. Collateral.
Based on only the coverage ratios in Exhibit 4, the company with the highest credit quality is:A. Company A.B. Company B.C. Company C.The following information relates EXHIBIT 4 Industrial
Credit yield spreads most likely widen in response to:A. High demand for bonds.B. Weak performance of equities.C. Strengthening economic conditions.
The factor that most likely results in corporate credit spreads widening is:A. An improving credit cycle.B. Weakening economic conditions.C. A period of high demand for bonds.
Credit spreads are most likely to widen:A. In a strengthening economy.B. As the credit cycle improves.C. In periods of heavy new issue supply and low borrower demand.
Which of the following factors would best justify a decision to avoid investing in a country’s sovereign debt?A. Freely floating currencyB. A population that is not growingC. Suitable checks and
The spot rates for three hypothetical zero-coupon bonds (zeros) with maturities of one, two, and three years are given in the following table.Calculate the forward rate for a one-year zero issued one
Consider a two-year loan beginning in one year (A = 1, B = 3). The one-year spot rate is z1 = zA = 7% = 0.07. The three-year spot rate is z3 = zB = 9% = 0.09.Calculate the one-year discount factor:
Given the data and conclusions for z1, f1,1, and f2,1 from Example 2:Show that the two-year spot rate of z2 = 10% and the three-year spot rate of z3 = 11% are geometric averages of the one-year spot
Given the spot rates z1 = 9%, z2 = 10%, and z3 = 11%:Determine whether the forward rate f1,2 is greater than or less than the long-term rate, z3.
Recall from earlier examples the spot rates z1= 9%, z2 = 10%, and z3 = 11%. Let yT be the YTM.Calculate the price of a two-year annual coupon bond using the spot rates. Assume the coupon rate is 6%
When the spot curve is upward sloping, the forward curve:A. Lies above the spot curve.B. Lies below the spot curve.C. Is coincident with the spot curve.
Suppose a government spot curve implies the following discount factors:Given this information, determine the swap rate curve. DF₁ = 0.9524 DF₂ = 0.8900 DF3 = 0.8163 DF4=0.7350
The “rolling down the yield curve” strategy is executed by buying bonds whose maturities are:A. Equal to the investor’s investment horizon.B. Longer than the investor’s investment horizon.C.
Many fixed-income portfolio managers are limited in or prohibited from high-yield bond investments. When a bond is downgraded from an investment-grade to a high-yield (junk) rating, it is referred to
The most important factor in explaining changes in the yield curve has been found to be:A. Level.B. Curvature.C. Steepness.
Morgan Salaz is a fixed income analyst responsible for advising fixed income clients about bond trading opportunities. In the current recessionary environment, the level of government bond yields is
Given spot rates for one-, two-, and three-year zero coupon bonds, how many forward rates can be calculated?
The spot rates for three hypothetical zero-coupon bonds (zeros) with maturities of one, two, and three years are given in the following table.Calculate the forward rate for a one-year zero issued two
Consider a two-year loan beginning in one year (A = 1, B = 3). The one-year spot rate is z1 = zA = 7% = 0.07. The three-year spot rate is z3 = zB = 9% = 0.09.Calculate the three-year discount factor:
Given the spot rates z1 = 9%, z2 = 10%, and z3 = 11%:Determine whether forward rates rise or fall as the initiation date, A, for the forward rate is later.
Recall from earlier examples the spot rates z1= 9%, z2 = 10%, and z3 = 11%. Let yT be the YTM.Calculate the price of a three-year annual coupon-paying bond using the spot rates. Assume the coupon
Which of the following statements concerning the YTM of a default-risk-free bond is most accurate? The YTM of such a bond:A. Equals the expected return on the bond if the bond is held to maturity.B.
A bond will be overvalued if the expected spot rate is:A. Equal to the current forward rate.B. Lower than the current forward rate.C. Higher than the current forward rate.
The term structure theory in which investors can be induced by relatively attractive yields to hold debt securities whose maturities do not match their investment horizon is best described as the:A.
A movement of the yield curve in which the short rate decreases by 150 bps and the long rate decreases by 50 bps would best be described as a:A. Flattening of the yield curve resulting from changes
Morgan Salaz is a fixed income analyst responsible for advising fixed income clients about bond trading opportunities. In the current recessionary environment, the level of government bond yields is
Give two interpretations for the following forward rate: The two-year forward rate one year from now is 2%.
The spot rates for three hypothetical zero-coupon bonds (zeros) with maturities of one, two, and three years are given in the following table.Calculate the forward rate for a two-year zero issued one
Consider a two-year loan beginning in one year (A = 1, B = 3). The one-year spot rate is z1 = zA = 7% = 0.07. The three-year spot rate is z3 = zB = 9% = 0.09.Calculate the forward price of a two-year
When the spot curve is downward sloping, a later initiation date results in a forwardcurve that is:A. Closer to the spot curve.B. A greater distance above the spot curve.C. A greater distance below
Assume a flat yield curve of 6%. A three-year £100 bond is issued at par paying an annual coupon of 6%. What is the portfolio manager’s expected return if he predicts that the yield curve one year
The unbiased expectations theory assumes investors are:A. Risk averse.B. Risk neutral.C. Risk seeking.
The yield curve starts off flat, and then intermediate-maturity yields decrease by 10 bps while short- and long-maturity yields remain constant. This movement is best described as involving a change
Describe the relationship between forward rates and spot rates if the yield curve is flat.
The spot rates for three hypothetical zero-coupon bonds (zeros) with maturities of one, two, and three years are given in the following table.Based on your answers to 1 and 2, describe the
Consider a two-year loan beginning in one year (A = 1, B = 3). The one-year spot rate is z1 = zA = 7% = 0.07. The three-year spot rate is z3 = zB = 9% = 0.09.Interpret your answer to Problem
A forward contract price will increase if:A. Future spot rates evolve as predicted by current forward rates.B. Future spot rates are lower than what is predicted by current forward rates.C. Future
Market evidence shows that forward rates are:A. Unbiased predictors of future spot rates.B. Upwardly biased predictors of future spot rates.C. Downwardly biased predictors of future spot rates.
Typically, short-term interest rates:A. Are less volatile than long-term interest rates.B. Are more volatile than long-term interest rates.C. Have about the same volatility as long-term interest
A. Define the yield-to-maturity for a coupon bond.B. Is it possible for a coupon bond to earn less than the yield-to-maturity if held to maturity?
Based on Exhibit 1, the five-year spot rate is closest to:A. 4.40%.B. 4.45%.C. 4.50%.Jane Nguyen is a senior bond trader for an investment bank, and Chris Alexander is a junior bond trader at the

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