Reading 63: Risks Associated with Investing in Bonds - LO problems, payments, interest, situation, par

cfaedu

1.Biggs, Inc., holds a bond portfolio that is, on average, trading below par value. They have faced some cash flow problems of late and have used the bond interest payments for operating expenses. The bonds are callable. Given the current situation, Biggs faces which types of risk?

A)   Call risk.

B)   Interest rate risk and reinvestment risk.

C)   Interest rate risk and call risk.

D)   Interest rate risk.

2.Which of the following situations lead to short-term profit opportunities in the bond market?

A)   Yields of all maturities start to rise.

B)   The increasing use of deferred call privileges.

C)   Inflation is expected to rise.

D)   Interest rates become more volatile.

3.The interest rate risk of a bond is the:

A)   risk related to the possibility of bankruptcy of the bond's issuer.

B)   unsystematic risk caused by factors unique in the bond.

C)   risks related to the possibility of bankruptcy of the bond's issuer and that arises from the uncertainty of the bond's return caused by the change in interest rates.

D)   risk that arises from the uncertainty about the bond's return caused by changes in interest rates over time.

cfaedu

答案和详解如下：

1.Biggs, Inc., holds a bond portfolio that is, on average, trading below par value. They have faced some cash flow problems of late and have used the bond interest payments for operating expenses. The bonds are callable. Given the current situation, Biggs faces which types of risk?

A)   Call risk.

B)   Interest rate risk and reinvestment risk.

C)   Interest rate risk and call risk.

D)   Interest rate risk.

The correct answer was D)

The bonds are trading below par, so rates have increased and, at this point, neither call risk nor reinvestment risk are significant. The firm faces interest rate risk because their bond portfolio has decreased in value due to increasing market interest rates.

2.Which of the following situations lead to short-term profit opportunities in the bond market?

A)   Yields of all maturities start to rise.

B)   The increasing use of deferred call privileges.

C)   Inflation is expected to rise.

D)   Interest rates become more volatile.

The correct answer was D)

As interest rates become more volatile, accurate pricing of bonds becomes more difficult, and thus some bonds are likely to be priced incorrectly. This pricing discrepancy will allow for short-term profit opportunities by buying a bond that is priced too low and selling it at the market rate. Increases in inflation expectations or yield to maturities indicate increasing market required rates of returns for bonds. Bond prices typically have an inverse relationship to interest rates.

3.The interest rate risk of a bond is the:

A)   risk related to the possibility of bankruptcy of the bond's issuer.

B)   unsystematic risk caused by factors unique in the bond.

C)   risks related to the possibility of bankruptcy of the bond's issuer and that arises from the uncertainty of the bond's return caused by the change in interest rates.

D)   risk that arises from the uncertainty about the bond's return caused by changes in interest rates over time.

The correct answer was D)

Interest rate risk is the probability of an increase in interest rates causing a bond's price to decrease.