Reading 63: Risks Associated with Investing in Bonds - LO

答案和详解如下：

16.Which of the following statements about the call feature is FALSE? The:

A)   call feature exposes investors to additional reinvestment rate risk.

B)   call feature lengthens the bond's duration, increasing price risk.

C)   cash flow pattern of callable bonds cannot be known with certainty.

D)   call feature reduces the bond's capital appreciation potential.

The correct answer was B)

A call provision decreases the bond's duration because a call provision introduces prepayment risk that should be factored in the calculation.

For the investor, one of the most significant risks of  callable (or prepayable) bonds is that they can be called/retired prematurely. Because bonds are nearly always called for prepayment after interest rates have decreased significantly, the investor will find it nearly impossible to find comparable investment vehicles Thus, investors have to replace their high-yielding bonds with much lower-yielding issues. From the bondholder’s perspective, a called bond means not only a disruption in cash flow but also a sharply reduced rate of return.

Generally speaking, the following conditions apply to callable bonds:

§ The cash flows associated with callable bonds become unpredictable, since the life of the bond could be much shorter than its term to maturity, due to the call provision.

§ The bondholder is exposed to the risk of investing the proceeds of the bond at lower interest rates after the bond is called. This is known as reinvestment risk.

§ The potential for price appreciation is reduced, because the possibility of a call limits or caps the price of the bond near the call price if interest rates fall (also known as price compression).

17.Which of the following is closest to the maximum price for a bond that is currently callable?

A)   Its par value.

B)   The call price.

C)   Its par value plus accrued interest.

D)   The present value of its par value.

The correct answer was B)

When interest rates fall, causing the price of the bond to increase above the call price, the issuer is likely to call the bond. Therefore the call price acts as a limit on the bond price. The call price is not necessarily equal to the par value.

18.A portfolio manager anticipates a major increase in market interest rates. Which trading strategy would be most likely to generate above average returns in a bond investment? Purchasing:

A)   long maturity bonds with low coupon rates.

B)   speculative grade bonds with high coupon rates.

C)   bonds that will increase the average duration of the investment portfolio.

D)   short maturity bonds with high coupon rates.

The correct answer was D)

The price volatility of non-callable bonds is inversely related to the level of market yields. As yields increase, bond prices fall, and the price curve gets flatter. Bond price sensitivity is lowest when yields are high. Longer maturity bonds with lower coupon rates are more sensitive to interest rate risk and their price will decrease more than short term, high coupon rate bonds. Speculative bonds become more risky in high interest rate environments.

19.Which of the following bonds, all else equal, would be the most sensitive to interest rate changes?

A)   5% coupon, 25 years to maturity.

B)   10% coupon, 5 years to maturity.

C)   10% coupon, 25 years to maturity.

D)   5% coupon, 5 years to maturity.

The correct answer was A)

Long-term, low coupon bonds are more sensitive to rate changes.