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fixed income analysis
Fixed Income Analysis 3rd Edition Barbara S. Petitt, Jerald E. Pinto, Wendy L. Pirie, Bob Kopprasch - Solutions
Using Exhibit 2 , the par value of 10-year bonds to be purchased to execute Alonso’s strategy is closest to:A . $5,072,000.B . $5,489,000.C . $5,511,000.
Using Alonso’s forecasted price and the bond information in Exhibit 2 , the expected 6-month total return of the Treasury 4.125% 15 May 2011 is closest to (assume zero accrued interest at purchase):A . −0.90%.B . 1.15%.C . 1.56%.
Regarding the three factors identifi ed by Alonso, the factor least likely to actually limit a manager’s ability to replicate a bond index is:A. #1.B . #2.C . #3.
Based on the data in Exhibit 1 , the bond portfolio strategy used by the fi red manager can best be described as:A . pure bond index matching.B . enhanced indexing/matching risk factors.C . active management/larger risk factor mismatches.
Th e spread duration of the Rojas University fi xed-income portfolio in Exhibit 1 is closest to:A . 2.58.B . 4.93.C . 5.21.
Th e duration of the Rojas University fi xed-income portfolio in Exhibit 1 is closest to:A . 5.11.B . 5.21.C . 5.33.
EXHIBIT 2 US Treasury Bond Information Issue Description (Term to Maturity, Ticker, Coupon, Maturity Date) Duration Price* ($) Yield (%)5-year: T 4.125% 15 May 2011 4.53 100.40625 4.03 10-year: T 5.25% 15 May 2016 8.22 109.09375 4.14*Prices are shown per $100 par value.
Th e investment committee hires Alfredo Alonso, a consultant from MHC Consulting, to assess the portfolio’s risks, submit ideas to the committee, and manage the portfolio on an interim basis.EXHIBIT 1 Rojas University Endowment Fixed-Income Portfolio Information Portfolio Index Sector % Duration*
You are the manager of a portfolio consisting of three bonds in equal par amounts of$1,000,000 each. Th e fi rst table below shows the market value of the bonds and their durations. (Th e price includes accrued interest.) Th e second table contains the market value of the bonds and their durations
Th e table below shows the spread duration for a 70-bond portfolio and a benchmark index based on sectors. Determine whether the portfolio or the benchmark is more sensitive to changes in the sector spread by determining the spread duration for each. Given your answer, what is the eff ect on the
Th e table below shows the active return for six periods for a bond portfolio. Calculate the portfolio’s tracking risk for the six-period time frame.Period Portfolio Return Benchmark Return Active Return 1 14.10% 13.70% 0.400%2 8.20 8.00 0.200 3 7.80 8.00 −0.200 4 3.20 3.50 −0.300 5 2.60 2.40
Th e Z-spread of Bond A is 1.05% and the Z-spread of Bond B is 1.53%. All else equal, which statement best describes the relationship between the two bonds?A . Bond B is safer and will sell at a lower price.B . Bond B is riskier and will sell at a lower price.C . Bond A is riskier and will sell at
A four-year corporate bond with a 7% coupon has a Z-spread of 200 bps. Assume a fl at yield curve with an interest rate for all maturities of 5% and annual compounding. Th e bond will most likely sell:A . close to par.B . at a premium to par.C . at a discount to par.
If the three-month T-bill rate drops and the Libor rate remains the same, the relevant TED spread:A . increases.B . decreases.C . does not change.
A two-year fi xed-for-fl oating Libor swap is 1.00% and the two-year US Treasury bond is yielding 0.63%. Th e swap spread is closest to:A . 37 bps.B . 100 bps.C . 163 bps.
In a typical interest rate swap contract, the swap rate is best described as the interest rate for the:A . fi xed-rate leg of the swap.B . fl oating-rate leg of the swap.C . diff erence between the fi xed and fl oating legs of the swap.
Th e one-year spot rate r (1) = 5% and the forward price for a one-year zero-coupon bond beginning in one year is 0.9346. Th e spot price of a two-year zero-coupon bond is closest to:A . 0.87.B . 0.89.C . 0.93.
Th e one-year spot rate r (1) = 4%, the forward rate for a one-year loan beginning in one year is 6%, and the forward rate for a one-year loan beginning in two years is 8%. Which of the following rates is closest to the three-year spot rate?A . 4.0%B . 6.0%C . 8.0%
Th e fi ve-year spot rate is not given above; however, the forward price for a two-year zero-coupon bond beginning in three years is known to be 0.8479. Th e price today of a fi ve-year zero-coupon bond is closest to:A . 0.7119.B . 0.7835.C . 0.9524.
Th e forward rate for a two-year loan beginning in one year is closest to:A . 5.0%B . 6.0%C . 7.0%
Th e rate for a one-year loan beginning in one year is closest to:A . 4.5%.B . 5.0%.C . 6.0%.
If one-period forward rates are decreasing with maturity, the yield curve is most likely:A . fl at.B . upward-sloping.C . downward sloping.Th e following information relates to Questions 16–29 A one-year zero-coupon bond yields 4.0%. Th e two- and three-year zero-coupon bonds yield 5.0% and 6.0%
Consider spot rates for three zero-coupon bonds: r (1) = 3%, r (2) = 4%, and r (3) = 5%. Which statement is correct? Th e forward rate for a one-year loan beginning in one year will be:A . less than the forward rate for a one-year loan beginning in two-years.B . greater than the forward rate for a
A . List the three factors that have empirically been observed to aff ect Treasury security returns and explain how each of these factors aff ects returns on Treasury securities.B . What has been observed to be the most important factor in aff ecting Treasury returns?C . Which measures of yield
Describe how the Z-spread can be used to price a bond.
Explain the strategy of riding the yield curve.
If a bond trader believes that current forward rates overstate future spot rates, how might he or she profi t from that conclusion?
Th e factor that is currently least likely to aff ect the risk-return characteristics of Bond #9 is:A . Interest rate movements.B . Whorton’s credit spreads.C . Whorton’s common stock price movements.
Th e minimum value of Bond #9 is equal to the greater of:A . the conversion value of Bond #9 and the current value of Bond #10.B . the current value of Bond #10 and a call option on Whorton’s common stock.C . the conversion value of Bond #9 and a call option on Whorton’s common stock.
Th e value of Bond #9 is equal to the value of Bond #10:A . plus the value of a put option on Whorton’s common stock.B . plus the value of a call option on Whorton’s common stock.C . minus the value of a call option on Whorton’s common stock.
Th e value of Bond #8 is closest to:A . 98.116% of par.B . 100.000% of par.C . 100.485% of par.
Th e value of Bond #7 is closest to:A . 99.697% of par.B . 99.936% of par.C . 101.153% of par.
Th e eff ective duration of Bond #4 is closest to:A . 0.76.B . 1.88.C . 3.77.
In Exhibit 2 , the bond whose eff ective duration will lengthen if interest rates rise is:A . Bond #3.B . Bond #4.C . Bond #5.
Th e eff ective duration of Bond #6 is:A . lower than or equal to 1.B . higher than 1 but lower than 3.C . higher than 3.
Based on Exhibit 1 , Rayes would most likely conclude that relative to Bond #1, Bond #2 is:A . overpriced.B . fairly priced.C . underpriced.
If the market price of Pro Star’s common stock falls from its level on 19 October 20X0, the price of the convertible bond will most likely:A . fall at the same rate as Pro Star’s stock price.B . fall but at a slightly lower rate than Pro Star’s stock price.C . be unaff ected until Pro
Th e conversion price of the bond in Exhibit 3 is closest to:A . $26.67.B . $32.26.C . $34.19.
All else being equal, if the shape of the yield curve changes from upward sloping to fl attening, the value of the option embedded in Bond #2 will most likely:A . decrease.B . remain unchanged.C . increase.
All else being equal, if Ferguson assumes an interest rate volatility of 15% instead of 10%, the bond that would most likely increase in value is:A . Bond #1.B . Bond #2.C . Bond #3.
All else being equal, a rise in interest rates will most likely result in the value of the option embedded in Bond #3:A . decreasing.B . remaining unchanged.C . increasing.
Th e value of Bond #3 is closest to:A . 102.103% of par.B . 103.688% of par.C . 103.744% of par.
Th e value of Bond #2 is closest to:A . 102.103% of par.B . 103.121% of par.C . 103.744% of par.
A fall in interest rates would most likely result in:A . a decrease in the eff ective duration of Bond #3.B . Bond #3 having more upside potential than Bond #2.C . a change in the eff ective convexity of Bond #3 from positive to negative.
Th e bond that would most likely protect investors against a signifi cant increase in interest rates is:A . Bond #1.B . Bond #2.C . Bond #3.
Th e call feature of Bond #2 is best described as:A . European style.B . American style.C . Bermudan style.
Based on Exhibit 4 and using Method 2, the correct price for Bond X is closest to:A . 97.2998.B . 109.0085.C . 115.0085.
Method 1 would most likely not be an appropriate valuation technique for the bond issued by:A . Hutto-Barkley Inc.B . Luna y Estrellas Intl.C . Peaton Scorpio Motors.
Based on Exhibits 2 and 3 and using Method 1, the amount (in absolute terms) by which the Hutto-Barkley corporate bond is mispriced is closest to:A . 0.3368 per 100 of par value.B . 0.4682 per 100 of par value.C . 0.5156 per 100 of par value.
Based on Exhibit 1 , which of the following bonds most likely includes an arbitrage opportunity?A . Bond A B . Bond B C . Bond C
If the assumed volatility is changed as Black requested in Task 4, the forward rates shown in Exhibit 3 will most likely :A . spread out.B . remain unchanged.C . converge to the spot rates.
A benefi t of performing Task 1 is that it:A . enables the model to price bonds with embedded options.B . identifi es benchmark bonds that have been mispriced by the market.C . allows investors to realize arbitrage profi ts through stripping and reconstitution.
Based on the information in Exhibits 3 and 4 , the bond price in euros at Node 1–2 in Exhibit 4 is closest to:A . 102.7917.B . 104.8640.C . 105.2917.
Which of the following statements about the missing data in Exhibit 3 is correct?A . Node 3–2 can be derived from Node 2–2.B . Node 4–1 should be equal to Node 4–5 multiplied by e0.4 .C . Node 2–2 approximates the implied one-year forward rate one year from now.
Based on Exhibits 1 and 2 , the exchange that refl ects the arbitrage-free price of the bond is:A . Eurex.B . Frankfurt.C . NYSE Euronext.
Based on Exhibit 1 , the best action that an investor should take to profi t from the arbitrage opportunity is to:A . buy on Frankfurt, sell on Eurex.B . buy on NYSE Euronext, sell on Eurex.C . buy on Frankfurt, sell on NYSE Euronext.
Which of the following best describes the cash fl ow that owners of credit card receivable-backed securities receive during the lockout period?A . Only principal payments collected B . Only fi nance charges and fees collected C . No cash fl ow is received as all cash fl ow collected is reinvested.
An excess spread account incorporated into a securitized structure is designed to limit:A . credit risk.B . extension risk.C . contraction risk.
Which commercial mortgage-backed security (CMBS) characteristic causes CMBS to trade more like a corporate bond than an agency residential mortgage-backed security(RMBS)?A . Call protection B . Internal credit enhancement C . Debt-to-service coverage ratio level
Credit risk is a factor for commercial mortgage-backed securities because they are backed by mortgage loans that:A . are non-recourse.B . have limited call protection.C . have no prepayment penalty points.
From a lender’s perspective, balloon risk can best be described as a type of:A . extension risk.B . contraction risk.C . interest rate risk.
In the context of mortgage-backed securities, a conditional prepayment rate (CPR) of 8%means that approximately 8% of an outstanding mortgage pool balance at the beginning of the year will be prepaid:A . in the current month.B . by the end of the year.C . over the life of the mortgages.
Maria Nyugen is an analyst for an insurance company that invests in residential mortgage pass-through securities. Nyugen reviews the monthly cash fl ow of one underlying mortgage pool to determine the cash fl ow to be passed through to investors:Total principal paid including prepayment $1,910,542
Which of the following describes a typical feature of a non-agency residential mortgage-backed security (RMBS)?A . Senior-subordinate structure in bond classes B . A pool of conforming mortgages as collateral C . A guarantee by the appropriate government sponsored enterprise (GSE)
Anne Bogaert reviews the status of her home mortgage schedule for the month of January 2014:Date Item Balance 01 January 2014 Outstanding mortgage loan balance $500,000 31 January 2014 Total monthly required payment $10,000 31 January 2014 Interest component of total monthly required payment $2,500
Fran Martin obtains a non-recourse mortgage loan for $500,000. One year later, when the outstanding balance of the mortgage is $490,000, Martin cannot make his mortgage payments and defaults on the loan. Th e lender forecloses on the loan and sells the house for $315,000. What amount is the lender
William Marolf obtains a 5 million EUR mortgage loan from Bank Nederlandse. A year later the principal on the loan is 4 million EUR and Marolf defaults on the loan. Bank Nederlandse forecloses, sells the property for 2.5 million EUR, and is entitled to collect the shortfall, 1.5 million EUR, from
In a securitization structure, time tranching provides investors with the ability to choose between:A . extension risk and contraction risk.B . fully amortizing loans and partially amortizing loans.C . senior bonds and subordinate bonds.
In a securitization, a special purpose vehicle (SPV) is responsible for the:A . issuance of the asset-backed securities.B . collection of payments from the borrowers.C . recovery of underlying assets for delinquent loans.
Which of Cassidy’s statements relating to the similarities and diff erences between the credit analysis of ABS and corporate bonds is incorrect ?A . Statement 1 B . Statement 2 C . Statement 3
Based on Exhibit 1, the present value of the expected loss due to credit risk relating to the single promised payment scheduled on February 15, 2017, is closest to:A . 0.04.B . 0.08.C . 0.11.
Based on Exhibit 1, the present value of the expected loss due to credit risk on the bond is closest to:A . 1.84.B . 16.16.C . 18.00.
Compared to a structural model, an advantage of the model chosen by Moriarty to analyze DD’s bond is most likely that:A . its measures refl ect the changing business cycle.B . it requires a specifi cation of the company’s balance sheet.C . it is possible to estimate the expected present value
Compared to a structural model, which of the following estimation approaches will Moriarty’s choice of credit model allow him to use?A . Implicit B . Historical C . Calibration
Th e model chosen by Moriarty to analyze one of DD’s bonds requires that:A . the equity of DD is traded.B . the assets of DD are traded.C . some of the debt of DD is traded.
Given Moriarty’s hint, Cassidy should most likely identify the type of security as a European:A . put option.B . call option.C . debt option.
Which of Cassidy’s stated limitations of credit ratings is incorrect ?A . Limitation A B . Limitation B C . Limitation C
Based on the information in Exhibit 3, the credit rating of Davide Campari-Milano S.p.A.is most likely:A. lower than Associated British Foods plc.B. higher than Associated British Foods plc.C. the same as Associated British Foods plc.
Based on the information in Exhibit 2, Grupa Zywiec SA’s credit risk is most likely:A. lower than the industry.B. higher than the industry.C. the same as the industry
Funds from operations (FFO) of Pay Handle Ltd increased in 2011. In 2011 the total debt of the company remained unchanged, while additional common shares were issued.Pay Handle Ltd’s ability to service its debt in 2011, as compared to 2010, most likely:A. improved.B. worsened.C. remained the same.
Th e following information is from the annual report of Adidas AG for December 2010:• Depreciation and amortization: €249 million• Total assets: €10,618 million• Total debt: €1,613 million• Shareholders’ equity: €4,616 million Th e debt/capital ratio of Adidas AG is closest to:A.
Based on the information provided in Exhibit 1, the EBITDA interest coverage ratio of Adidas AG is closest to:A. 7.91x.B. 10.12x.C. 12.99x.EXHIBIT 1 Adidas AG Excerpt from Consolidated Income Statement Year Ending 31 December 2010 (€ in millions)Gross Profi t 5,730 Royalty and commission income
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 companies are cyclical, whereas the beverage company is non-cyclical. Th e construction company has the
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 fl ow before dividends.B. there is a low likelihood that the market price of the company’s common stock is below book value.C. a large percentage of the
During bankruptcy proceedings of a fi rm, 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. Th e value of secured assets was less than the amount of the claims.C. A judge’s order resulted
In the event of default, debentures’ claims will most likely rank:A. above that of secured debt holders.B. below that of secured debt holders.C. the same as that of secured debt holders.
A manufacturing company receives a ratings upgrade and the price increases on its fi xedrate bond. Th e price increase was most likely caused by a(n):A . decrease in the bond’s credit spread.B . increase in the bond’s liquidity spread.C . increase of the bond’s underlying benchmark rate.Th e
An investor purchases an annual coupon bond with a 6% coupon rate and exactly 20 years remaining until maturity at a price equal to par value. Th e investor’s investment horizon is eight years. Th e approximate modifi ed duration of the bond is 11.470 years. Th e duration gap at the time of
A bond has an annual modifi ed duration of 7.140 and annual convexity of 66.200. Th e bond’s yield-to-maturity is expected to increase by 50 bps. Th e expected percentage price change is closest to:A . –3.40%.B . –3.49%.C . –3.57%.
A bond has an annual modifi ed duration of 7.020 and annual convexity of 65.180. If the bond’s yield-to-maturity decreases by 25 bps, the expected percentage price change is closest to:A . 1.73%.B . 1.76%.C . 1.78%.
A bond is currently trading for 98.722 per 100 of par value. If the bond’s yield-to-maturity(YTM) rises by 10 bps, the bond’s full price is expected to fall to 98.669. If the bond’s YTM decreases by 10 bps, the bond’s full price is expected to increase to 98.782. Th e bond’s approximate
Using the information below, which bond has the greatest money duration per 100 of par value assuming annual coupon payments and no accrued interest?Bond Time-toMaturity Price Per 100 of Par Value Coupon Rate Yield-toMaturity Modifi ed Duration A 6 years 85.00 2.00% 4.95% 5.42 B 10 years 80.00
A limitation of calculating a bond portfolio’s duration as the weighted average of the yield durations of the individual bonds that compose the portfolio is that it:A . assumes a parallel shift to the yield curve.B . is less accurate when the yield curve is less steeply sloped.C . is not
A bond portfolio consists of the following three fi xed-rate bonds. Assume annual coupon payments and no accrued interest on the bonds. Prices are per 100 of par value.Bond Maturity Market Value Price Coupon Yield-toMaturity Modifi ed Duration A 6 years 170,000 85.0000 2.00% 4.95% 5.42 B 10 years
Which of the following statements about Macaulay duration is correct?A . A bond’s coupon rate and Macaulay duration are positively related.B . A bond’s Macaulay duration is inversely related to its yield-to-maturity.C . Th e Macaulay duration of a zero-coupon bond is less than its
A Canadian pension fund manager seeks to measure the sensitivity of her pension liabilities to market interest rate changes. Th e manager determines the present value of the liabilities under three interest rate scenarios: a base rate of 7%, a 100 bp increase in rates up to 8%, and a 100 bp drop in
Which of the following statements about duration is correct? A bond’s:A . eff ective duration is a measure of yield duration.B . modifi ed duration is a measure of curve duration.C . modifi ed duration cannot be larger than its Macaulay duration.
An investor buys a three-year bond with a 5% coupon rate paid annually. Th e bond, with a yield-to-maturity of 3%, is purchased at a price of 105.657223 per 100 of par value.Assuming a 5 bp change in yield-to-maturity, the bond’s approximate modifi ed duration is closest to:A . 2.78.B . 2.86.C .
Assuming that all coupons are reinvested over the holding period, the investor’s fi ve-year horizon yield is closest to:A . 5.66%.B . 6.62%.C . 7.12%.
Th e capital gain/loss per 100 of par value resulting from the sale of the bond at the end of the fi ve-year holding period is closest to a:A . loss of 8.45.B . loss of 3.31.C . gain of 2.75.
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