burning0spear

A bond-portfolio manager is considering adding a position to the portfolio. He is choosing between a domestic bond with a duration equal to 4.8 or a foreign bond that has a duration of 6.0 and a country beta equal to 0.8. If the manager wishes to add the bond with the lower sensitivity to domestic interest rates, the manager:

A) would choose the foreign bond.

B) would choose the domestic bond.

C) would be indifferent between the two bonds.

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Both bonds have the same sensitivity to domestic rates: 6.0 × 0.8 = 4.8.

burning0spear

Which of the following is a valid reason for NOT using forwards to hedge exposure to currency risk? The portfolio manager expects:

A) the future currency exchange rate to be less than the forward exchange rate.

B) that the percentage return from exposure to a currency is greater than the forward discount or premium.

C) home interest rates to rise relative to foreign interest rates.

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If the return from being exposed to a currency is greater than the forward premium, then using the forward to hedge will result in a return less than that if there were no hedge.

burning0spear

Which of the following most accurately describes the purpose of using break-even analysis (forward rates) to make relative value decisions? Break-even analysis is used to determine:

A) whether or not to hedge.

B) the currency risk isolated from interest rate risk for different markets.

C) the credit risk isolated from interest rate risk for different markets.

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The strategic outlook is what you "expect" to happen to the currency. The market price can be determined from the forward rate. Comparing the two dictates whether you should hedge or not hedge (which is the ultimate decision).

burning0spear

Which of the following statements concerning how breakeven rate analysis can be used to make relative value or currency hedging decisions between foreign bond markets is CORRECT? Break-even analysis can be used to:

A) quantify the amount of spread widening that would erase the yield advantage from investing in a higher yielding market.

B) quantify the correct amount of currency exposure to hedge.

C) identify mispriced bonds in foreign markets and to take advantage of the mispricing.

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Breakeven rate analysis can be used to determine how many basis points the spread would have to change in order for yield advantages to be eliminated.

burning0spear

Jack Hopper, CFA, manages a domestic bond portfolio and is evaluating two bonds. Bond A has a yield of 5.60% and a modified duration of 8.15. Bond B has a yield of 6.45% and a modified duration of 4.50. Hopper can realize a yield gain of 85 basis points with Bond B if there are no offsetting changes in the relative prices of the two bonds. Hopper has an expected holding period of six months. The breakeven change in the basis point (bp) spread due to a change in the yield on bond A is:

A) 5.21472 bp, due to a decline in the yield.

B) 10.42945 bp due to a decline in the yield.

C) 5.21472 bp due to an increase in the yield.

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By purchasing Bond B Hopper can realize a yield gain of (6.45 – 5.60) = 85 basis points if the yield spread does not increase. The yield advantage for the 6-month time horizon is (85/2) = 42.5 basis points to bond B. This is the yield advantage that must be offset in order to break even, hence we use 42.5 basis points in the formula to indicate the price of bond A will increase. Since we are looking at this from the standpoint of a change in yield on Bond A: (0.425/-8.15) x 100 = -5.21472, implying that the change in yield for bond A is -5.21472bp and the spread must increase by 5.21472 basis points. This change will result in capital gains for Bond A, which will offset B’s yield advantage.

burning0spear

Steve Kiteman, CFA, manages a domestic bond portfolio and is evaluating two bonds. Bond A has a yield of 6.42% and a modified duration of 11.45. Bond B has a yield of 8.25% and a modified duration of 9.50. Kiteman has an expected holding period of three months. The breakeven change in the spread due to a change in the yield on bond B is:

A) 4.12783 bp due to a decrease in the yield for Bond B.

B) 3.99563 bp due to an increase in the yield for Bond B.

C) 4.81579 bp due to an increase in the yield for Bond B.

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The Bond B has a yield advantage of 183 basis points. With a three-month investment time horizon, the yield advantage is (183/4) = 45.75 basis points. Since we are looking at this in terms of Bond B: (-0.4575/-9.50) x 100 = +4.81579bp, implying that the spread must increase by 4.81579 basis points. Hence, in terms of the yield on Bond B, the breakeven change in yield is +4.81579bp, or an increase in the yield on Bond B (thus resulting in the widening of the spread between A and B by this amount). This change will result in capital losses for Bond B, which will offset B’s original yield advantage. Note that the CFA curriculum specifies using the bond with the greater duration which in this case would be bond A although as we have demonstrated in this question the bond with the shorter duration can also be used. Thus, if you are not told which bond to use to perform the calculation you should use the one with the greater duration.

burning0spear

Mary Brickland, CFA, is analyzing two different domestic bonds. Bond A has the longer modified duration at 9.50 with a yield of 9.12%. Bond B has a modified duration of 7.30 and a yield of 7.80%. Brickland has an investment-holding period of one year and expects a favorable credit quality change for Bond B to increase its market value during this time frame. If Brickland buys Bond B, what is the required basis point change in the spread (in terms of the required yield on Bond B) to offset Bond A’s yield advantage?

A) 18.08219 bp due to a decline in the yield.

B) 13.89474 bp due to a decline in the yield.

C) 14.72190 bp due to an increase in the yield.

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Bond A has a yield advantage of 132 basis points relative to Bond B. An increase in Bond B’s credit rating will increase its price and lower its yield. Since we are looking at this in terms of Bond B: (1.32/-7.30) x 100 = -18.08219bp, the breakeven change in yield is –18.08219bp, or a decline in the yield on Bond B meaning interest rates are going to go down by this much resulting in the widening of the spread between A and B by this amount. The increase in price for Bond B will result in capital gains for Bond B, which will offset A’s original yield advantage. Note that the CFA curriculum specifies using the bond with the greater duration which in this case would be bond A although as we have demonstrated in this question the bond with the shorter duration can also be used. Thus, if you are not told which bond to use to perform the calculation you should use the one with the greater duration.

burning0spear

When compared to the debt issued by corporations in developed nations, the sovereign debt of emerging market governments tend to have a:

A) lower level of standardized covenants and a less enforceable seniority structure.

B) lower level of standardized covenants but a more enforceable seniority structure.

C) higher level of standardized covenants but a less enforceable seniority structure.

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Sovereign debt typically lacks an enforceable seniority structure, in contrast to private debt, and little standardization of covenants exists among the various emerging market issuers.

burning0spear

Jill Upton, CFA, and Al Grey, CFA, are planning to add foreign bonds to the domestic portfolio, which they manage. They are discussing the advantage of adding bonds issued by sovereign emerging market governments. Compared to bonds issued by corporations, all of the following are advantages of sovereign emerging market government debt with EXCEPT:

A) the issuers tend to have reserves to absorb shocks.

B) the issuers can react more decisively to negative economic events.

C) the bonds are free of default risk.

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The other advantages listed are true along with lower default risk, but the bonds are not free of default risk. Governments have and will default on bonds.

burning0spear

In the emerging market debt market, it is generally true that volatility is:

A) low, and the returns have significant positive skewness.

B) high, and the returns have significant positive skewness.

C) high, and the returns have significant negative skewness.

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Volatility in the emerging market debt market is high, and the returns are also frequently characterized by significant negative skewness.