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In terms of a long-term investor, which of the following is a potential criticism of not investing in securities with low liquidity? These securities:
A)
offer arbitrage opportunities more frequently.
B)
are less risky.
C)
have to provide higher returns as a compensation for low liquidity.



Less liquid securities must provide a liquidity premium to compensate for the low liquidity.

TOP

Which of the following is a potential criticism of a strategy that invests in securities that are "neglected" by the market? This type of security:
A)
often has low liquidity.
B)
has a lower risk-return tradeoff.
C)
is often overpriced.



Since these securities are "neglected," liquidity is low and transaction costs high.

TOP

Which of the following statements about swaps is CORRECT?
A)
A swap spread is the spread paid by the fixed-rate payer over the seasoned Treasury rate.
B)
In the European market, swap spreads serve as a good proxy for credit spreads.
C)
A swap spread refers to the difference in yield between corporate issues of different quality ratings.



It is because of the relative homogeneity of the European bond market that swap spreads are a good proxy for credit spreads. European issues are generally high in quality and intermediate in maturity. Swap spreads involve the on-the-run Treasury rate, not seasoned issues.

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Which of the following statements about spread analysis is CORRECT?
A)
With quality-spread analysis, one risk when purchasing a security is the spread differential narrowing during the holding period.
B)
Percentage yield analysis uses the ratio between corporate bond yields and government yields and is the only spread analysis that is based on maturity rather than duration.
C)
Using quality-spread analysis, a bond portfolio manager would buy an issue that has a wider spread than what is justified by its intrinsic value.



If an issue trades at a spread that is (believed by the manager to be) higher than is warranted by its intrinsic value, the expectation is that this spread will decrease over time as this fact becomes understood by the market. The risk is that the manager has misjudged the quality of the issue, and that the spread could remain high or even widen further.

TOP

Which of the following market conditions would suggest the use of callable bond structures in a corporate bond portfolio?
A)
Bull bond market.
B)
Bear bond market.
C)
Increasing interest rate volatility and a bull bond market.



In a bear bond market interest rates are increasing causing bond values to decrease thus the probability of an early call decreases. Callable bonds are issued with a higher coupon rate as compared to noncallable bonds to compensate the purchaser for the probability of the bond being called. In a rising interest rate environment callable bonds will not fall in price as much as a comparable option free bond due to the negative convexity of the callable bond in the callable region of the bond. Thus, if portfolio managers expect interest rates to increase, they should buy callable structures instead of option-free bonds in order to capture the higher return of the callable bond since it will not fall in value as much as the non-callable bond.

TOP

One portfolio constraint contributing to market inefficiency in global credit markets is seasonality. Considering the trading patterns of a given mutual fund, which of the following is least likely to reflect seasonality?
A)
Relatively low secondary trading at the end of a month.
B)
Relatively low secondary trading following a portfolio rebalancing.
C)
Relatively high secondary trading following a new primary issue.



Seasonality has to do with monthly, quarterly, or yearly data that appears at regular time intervals. Secondary trading following a new primary issue would not have anything to do with a seasonal pattern of repeating time intervals. The other choices are standard reasons to slow (or speed) transactions on a regular periodic basis that would represent a seasonality pattern.

TOP

The capacity to pay is a relatively more important factor in which of the following types of credit analysis?
A)
Corporate.
B)
Sovereign.
C)
Long-term municipal.



Capacity to pay, often measured by the adequacy of cash flows available to meet interest payments, is the key factor in corporate credit analysis.

TOP

A bond manager deciding against making an otherwise desired secondary transaction because of a desire to minimize portfolio turnover is most likely an example of what type of portfolio constraint?
A)
Seasonality.
B)
Exposure Limits.
C)
Buy and Hold.



A disposition toward lower trading volume can lead to buy-and-hold behavior.

TOP

With regard to credit analysis, the quality of collateral and the servicer are most relevant to which types of securities?
A)
Municipal securities.
B)
Corporate securities.
C)
Asset-backed securities.



The quality of collateral and the servicer is most relevant to the analysis of asset-backed securities.

TOP

The most relevant challenge to bond portfolio managers in the area of credit analysis is related to which of the following issues?
A)
The capacity of corporate issuers to support cash flows needs.
B)
The expansion in the universe of global bonds.
C)
Global economic and political instability.



In order to be effective, managers must establish and support an effective credit analysis system within their managerial domains to assure that appropriate information is available to make the best possible choices. This is becoming increasingly difficult as the global bond universe expands.

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