标题: Fixed Income【Reading 54】Sample [打印本页]
作者: clearlycanadian 时间: 2012-3-30 16:08 标题: [2012 L1] Fixed Income【Session 15 - Reading 54】Sample
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? |
B)
| Interest rate risk and call risk. |
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The bonds are trading below par, so rates have increased and, at this point, call risk is not significant. The firm faces interest rate risk because their bond portfolio has decreased in value due to increasing market interest rates.
作者: clearlycanadian 时间: 2012-3-30 16:11
Which of the following situations lead to short-term profit opportunities in the bond market? A)
| Interest rates become more volatile. |
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B)
| Inflation is expected to rise. |
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C)
| Yields of all maturities start to rise. |
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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.
作者: clearlycanadian 时间: 2012-3-30 16:12
The interest rate risk of a bond is the: A)
| risk that arises from the uncertainty about the bond's return caused by changes in interest rates over time. |
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B)
| risk related to the possibility of bankruptcy of the bond's issuer. |
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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. |
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Interest rate risk is the probability of an increase in interest rates causing a bond's price to decrease.
作者: clearlycanadian 时间: 2012-3-30 16:13
Interest rate risk for a bond refers to the fact that when interest rates: A)
| decrease, the realized yield on the bond will be less than the yield to maturity. |
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B)
| increase, the bond’s value decreases. |
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C)
| increase, prepayments of principal will decrease. |
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Interest rate risk is the risk that the bond’s value will decrease because interest rates increase. Reinvestment risk is the risk that a bond’s cash flows will be reinvested at lower-than-expected rates. Prepayment risk refers to the fact that prepayments of a mortgage-backed security’s principal may differ from the expected rate.
作者: clearlycanadian 时间: 2012-3-30 16:16
Gabrielle Daniels and Edin Roth, CFA candidates, are discussing the relationship between a bond’s coupon rate and the required market yield. Looking through the local newspaper, they see a new-issue, 10-year, $1,000 face value 8% semi-annual coupon bond priced at $950. Daniels makes the following statements. Which statement does Roth tell her is correct?A)
| The bond is selling at a premium. |
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B)
| The current market required rate is less than the coupon rate. |
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C)
| The bond is selling at a discount. |
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When the issue price is less than par, the bond is selling at a discount.
We also know that the current market required rate is greater than the coupon rate because the bond is selling at a discount.
作者: clearlycanadian 时间: 2012-3-30 16:16
If the market rate of interest is greater than the coupon rate, the bond will be valued:
If the Coupon Rate > market yield, then bond will sell at a premium.
If the Coupon Rate < market yield, then bond will sell at a discount.
If the Coupon Rate = market yield, then bond will sell at par.
作者: clearlycanadian 时间: 2012-3-30 16:17
Given that the coupon rate of a bond is higher than the market interest rate on bonds with similar maturities and payment structures, the bond will be trading:
If the bond provides investors with a higher coupon rate than the market interest rate the bond has to be trading at a premium relative to its par value otherwise there is an arbitrage opportunity.
作者: clearlycanadian 时间: 2012-3-30 16:17
If a bond's coupon is greater than the prevailing market rate on new issues, the bond is called a:
When the coupon rate on a bond is higher than the prevailing market rate the bond will be selling at a premium. This occurs because the bonds price will be higher than the face value because as interest rate goes down price goes up.
作者: clearlycanadian 时间: 2012-3-30 16:17
Which of the following statements concerning the price volatility of bonds is most accurate? A)
| Bonds with higher coupons have lower interest rate risk. |
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B)
| Bonds with longer maturities have lower interest rate risk. |
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C)
| As the yield on callable bonds approaches the coupon rate, the bond's price will approach a "floor" value. |
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Bonds with higher coupons have lower interest rate risk. Note that the other statements are false. Bonds with longer maturities have higher interest rate risk. Callable bonds have a ceiling value as yields decline.
作者: clearlycanadian 时间: 2012-3-30 16:18
Which of the following statements about how the features of a bond impact interest rate risk is CORRECT? A)
| For a given change in yield, a higher coupon bond will experience a larger change in price than a lower-coupon bond. |
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B)
| Market yields are the most important determinant of bond price volatility. |
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C)
| Zero-coupon bonds have the highest price volatility. |
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Zero-coupon bonds have the highest interest rate risk because they deliver all their cash flows at maturity. Another way to think about this: A zero-coupon bond has the lowest coupon (0.00%), so it has the highest price volatility, since the coupon rate is inversely related to price volatility.
In addition to market yields, the timing and magnitude of cash flows affect price volatility. For a given change in yield, a higher coupon bond will experience a smaller change in price than a lower-coupon bond. The relationship between maturity and price volatility (all else equal) is direct – a greater maturity results in greater price volatility.
作者: clearlycanadian 时间: 2012-3-30 16:18
The factors that determine how changes in interest rates affect bond values include all of the following EXCEPT:
The issue price determines whether a bond is said to trade at a premium or at a discount. The change in price of a fixed-coupon bond is inversely related to the direction of the change in interest rates whether the bond was sold at a discount or at a premium. The other choices are correct factors.
作者: clearlycanadian 时间: 2012-3-30 16:18
Which of the following 10-year fixed-coupon bonds has the most price volatility? All else equal, the bond with a coupon rate of:
If bonds are identical except for the coupon rate, the one with the lowest coupon will exhibit the most price volatility. This is because a bond’s price is determined by discounting the cash flows. A lower-coupon bond pays more of its cash flows later (more of the cash flow is comprised of principal at maturity) than a higher-coupon bond does. Longer-term cash flows are discounted more heavily in the present value calculation. Another way to think about this: The relationship between the coupon rate and price volatility (all else equal) is inverse – a greater coupon results in less price volatility. Examination tip: If you get confused on the examination, remember that a zero-coupon bond has the highest interest rate risk because it delivers all its cash flows at maturity. Since a zero-coupon bond has a 0.00% coupon, a low coupon equates to high price volatility.
作者: clearlycanadian 时间: 2012-3-30 16:19
Which of the following fixed-coupon bonds has the least price volatility? All else equal, the bond with a maturity of:
If bonds are identical except for maturity, the one with the shortest maturity will exhibit the least price volatility. This is because a bond’s price is determined by discounting the value of the cash flows. A shorter-term bond pays its cash flows earlier than a longer-term bond, and near-term cash flows are not discounted as heavily. Another way to think about this: The relationship between maturity and price volatility (all else equal) is direct – a greater maturity results in greater price volatility.
作者: clearlycanadian 时间: 2012-3-30 16:19
Which of the following five year bonds has the highest interest rate sensitivity? |
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C)
| Option-free 5% coupon bond. |
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The duration of a zero-coupon bond is equal to its time to maturity. Its price is greatly affected by changes in interest rates because its only cash-flow is at maturity and is discounted from the time at maturity until the present.
作者: clearlycanadian 时间: 2012-3-30 16:20
Which of the following bonds has the highest interest rate sensitivity? A: A)
| ten year, option-free 4% coupon bond. |
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B)
| ten year, option-free 6% coupon bond. |
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C)
| five year, 5% coupon bond callable in one year. |
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If two bonds are identical in all respects except their term to maturity, the longer term bond will be more sensitive to changes in interest rates. All else the same, if a bond has a lower coupon rate when compared with another, it will have greater interest rate risk. Therefore, for the option-free bonds, the 10 year 4% coupon is the longest term and has the lowest coupon rate. The call feature does not make a bond more sensitive to changes in interest rates, because it places a ceiling on the maximum price investors will be willing to pay. If interest rates decrease enough the bonds will be called.
作者: clearlycanadian 时间: 2012-3-30 16:20
Which of the following statements about how the features of a bond impact interest rate risk is NOT correct? A)
| A lower-coupon bond is more sensitive to interest rate movements than a higher-coupon bond (all else equal). |
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B)
| Bond price movements depend upon the direction and magnitude of changes in interest rates. |
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C)
| An inverse relationship between interest rates and bond prices means that the greater the change in interest rates, the less the change in fixed-coupon bond prices. |
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The inverse relationship between interest rates and bond prices means that when interest rates increase, fixed-coupon bond prices decrease. In other words, the inverse relationship means that interest rates and bond prices move in opposite directions, it does not infer anything about the magnitude of the change.
The relationship between the coupon rate and price volatility (all else equal) is inverse – a greater coupon results in less price volatility. Remember, if you have a problem with this on the examination, keep in mind that a zero-coupon bond has the highest interest rate risk because it delivers all its cash flows at maturity. Since a zero-coupon bond has a 0.00% coupon, a low coupon equates to high price volatility.
作者: clearlycanadian 时间: 2012-3-30 16:20
Maria Cavilero, a bond investor, is most concerned with price volatility. All else equal, which of the following fixed-coupon bonds would she most likely buy? A fixed coupon-bond with: A)
| 10 years to maturity and a 6.5% coupon. |
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B)
| 10 years to maturity and an 8.5% coupon. |
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C)
| 15 years to maturity and an 8.5% coupon. |
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This question is asking: given a change in yield, which of the bonds will exhibit the least price change? Of the four choices, Cavilero is most likely to buy the bond with the shortest maturity and highest coupon because it will have the least price volatility. Price volatility is directly related to maturity and inversely related to the coupon rate.
All else equal, the bond with the shorter term to maturity is least sensitive to changes in interest rates. Cash flows that are further into the future are discounted more than near-term cash flows, so the nearer to maturity the cash flows are received, the higher the present value. Here, this means that one of the 10-year bonds will have the least volatility. Similar reasoning applies to the coupon rate. A higher coupon bond delivers more of its total cash flow earlier than a lower coupon bond. All else equal, a bond with a higher coupon will exhibit less price volatility than a lower-coupon bond. Here, this means that of the 10-year bonds, the one with the 8.50% coupon rate will exhibit less price volatility than the bond with the 6.50% coupon.
作者: clearlycanadian 时间: 2012-3-30 16:21
Which of the following statements about the call feature is least accurate? The: A)
| call feature lengthens the bond's duration, increasing price risk. |
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B)
| call feature exposes investors to additional reinvestment rate risk. |
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C)
| call feature reduces the bond's capital appreciation potential. |
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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).
作者: clearlycanadian 时间: 2012-3-30 16:21
Which of the following is closest to the maximum price for a bond that is currently callable? |
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C)
| Its par value plus accrued interest. |
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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.
作者: clearlycanadian 时间: 2012-3-30 16:21
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)
| bonds that will increase the average duration of the investment portfolio. |
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B)
| short maturity bonds with high coupon rates. |
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C)
| long maturity bonds with low coupon rates. |
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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.
作者: clearlycanadian 时间: 2012-3-30 16:22
Which of the following bonds, all else equal, would be the most sensitive to interest rate changes? A)
| 5% coupon, 25 years to maturity. |
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B)
| 10% coupon, 5 years to maturity. |
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C)
| 10% coupon, 25 years to maturity. |
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Long-term, low coupon bonds are more sensitive to rate changes.
作者: clearlycanadian 时间: 2012-3-30 16:22
All else equal, the lower the bond’s yield to maturity, the: A)
| shorter the duration and the lower the interest rate risk. |
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B)
| shorter the duration and the higher the interest rate risk. |
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C)
| longer the duration and the higher the interest rate risk. |
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A lower yield to maturity would result in a longer duration and higher interest rate risk.
作者: clearlycanadian 时间: 2012-3-30 16:22
Tom Wilkens is a portfolio manager and has a retiree as a client. The client would like to invest in bonds with low interest rate risk. Which bond should Tom choose for his client? The bond with a: A)
| 10 year maturity and a yield to maturity of 8%. |
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B)
| 20 year maturity and a yield to maturity of 5%. |
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C)
| 10 year maturity and a yield to maturity of 5%. |
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The shorter the bond’s maturity and the higher the yield to maturity, the shorter the duration and the lower the interest rate risk.
作者: clearlycanadian 时间: 2012-3-30 16:23
Which of the following bond features would result in lower interest rate risk? A: |
B)
| higher yield to maturity. |
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A higher yield to maturity would result in a shorter duration and lower interest rate risk. A longer maturity and lower coupon rate would result in longer durations and higher interest rate risk.
作者: clearlycanadian 时间: 2012-3-30 16:23
What will happen to interest rate risk for an option-free bond if market yields decrease? A)
| Interest rate risk will increase. |
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B)
| Interest rate risk will decrease. |
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C)
| Even if the term structure is flat, interest rate risk could go up or down based on the level of the term structure at the time market yields decrease. |
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If market yields decrease, interest risk will increase since the duration or the sensitivity of the bond to interest rate fluctuation will increase.
作者: optiix 时间: 2012-3-30 16:25
Which of the following statements about a bond with a call feature is least accurate? The call feature: A)
| reduces the bond's capital appreciation potential. |
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B)
| exposes investors to additional reinvestment rate risk. |
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C)
| increases the bond's duration, increasing price risk. |
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A call feature decreases a bond's duration.
作者: optiix 时间: 2012-3-30 16:25
If a portfolio manager anticipates a major increase in market interest rates, the most appropriate trading strategy is to purchase: A)
| long-maturity bonds with low coupon rates. |
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B)
| short-maturity bonds with high coupon rates. |
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C)
| high yield bonds with high coupon rates. |
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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. Bonds with higher duration will change more in price. 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. High yield ("junk") bonds with high coupons become more risky in high interest rate environments and therefore would not be appropriate.
作者: optiix 时间: 2012-3-30 16:25
Which of the following is an incorrect statement when zero-coupon bonds are compared to coupon-paying bonds with the same maturity? Zero-coupon bonds: A)
| have a higher duration. |
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B)
| are sold at a lower price. |
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C)
| are less sensitive to interest rate changes. |
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Since zero-coupon bonds have a higher duration than coupon-paying bonds of the same maturity, they are more sensitive to interest rate changes.
作者: optiix 时间: 2012-3-30 16:26
Which of the following statements about a callable bond is CORRECT? A)
| Callable bonds follow the standard inverse relationship between interest rates and price. |
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B)
| A bondholder usually loses if a bond is called by being forced to reinvest the proceeds at a lower interest rate. |
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C)
| The call option on a bond trades separately from the bond itself. |
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A bondholder will most likely lose if a bond is called because a bond is most likely to be called in a declining interest rate environment. The issuer will likely call the bond and replace it with lower cost (lower coupon debt). The holder faces prepayment and reinvestment risk, because he must reinvest the bond cash flows into lower-yielding current investments.
In bond trading, the call option is bundled with the bond and is not traded separately. The price of a callable bond does not follow the standard inverse relationship. As yields fall, the call option becomes more valuable to the issuer. With a decrease in interest rates, the value of a callable bond can only increase to approximately the call value. Straight bonds will continue to exhibit the inverse relationship between yields and prices as there is no ceiling call price. When yields rise, the value of callable bond may not fall as much as that of a similar straight bond because of the embedded call option feature.
作者: optiix 时间: 2012-3-30 16:26
Which of the following statements about the value of a callable bond is NOT correct? A)
| The value of a callable bond equals the value of the bond without the option plus the option value. |
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B)
| The value of the callable bond is less than the value of an option-free bond in an amount equal to the value of the call option. |
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C)
| When yields rise, the value of a callable bond may exhibit less of a price change than a noncallable bond. |
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The value of the call option is subtracted from the value of the bond without the option because the option is of value to the issuer, not the holder.
As interest rates decrease, the issuer values the call option more because the company has the potential to call the bond and replace existing debt with lower-coupon (and thus lower cost) debt. Also, it is more likely that the bond will be called. The other choices are correct.
作者: optiix 时间: 2012-3-30 16:27
When market rates were 6% an analyst observed a $1,000 par value callable bond selling for $950. At the same time the analyst also observed an identical non-callable bond selling for $980. What would the analyst estimate the value of the call option on the callable bond to be worth?
The noncallable bond has the traditional PY shape. The callable bond bends backwards. The difference between the two curves is the value of the option. 980 − 950 = $30.
作者: optiix 时间: 2012-3-30 16:27
If the volatility of interest rates increases, which of the following will experience the smallest price increase resulting from lower rates? |
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C)
| Zero-coupon option-free bond. |
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For a callable bond the issuer has the option to call the bond if the interest rate decreases during its call period. The issuer will call the bond if interest rates have decreased in order to obtain cheaper financing elsewhere. If the interest rate volatility increases the chance the it is optimal for the issuer to call the bond increases, making the call option more valuable. Therefore, the bond price is depressed by an increase in interest rate volatility.
作者: optiix 时间: 2012-3-30 16:27
As part of his job at an investment banking firm, Damian O’Connor, CFA, needs to calculate the value of bonds that contain a call option. Today, he must value a 10-year, 7.5% annual coupon bond callable in five years priced at 96.5 (prices are stated as a percentage of par). A straight bond that is similar in all other aspects as the callable bond is priced at 99.0. Which of the following is closest to the value of the call option?
To calculate the option value, rearrange the formula for a callable bond to look like:
Value of embedded call option = Value of straight bond – Callable bond value
Value of call option = 99.0 – 96.5 = 2.5.
Remember: The call option is of value to the issuer, not the holder.
作者: optiix 时间: 2012-3-30 16:28
Which of the following statements about the relationship between the value of a callable bond, the value of an option-free bond, and the value of the embedded call option is CORRECT? A)
| Value of a callable bond = present value of the interest payments + present value of the principal at maturity. |
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B)
| Value of a callable bond = value of an option-free bond − value of an embedded call option. |
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C)
| Value of a callable bond = value of an option-free bond + value of an embedded call option. |
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Because the bondholder has given something of value to the issue of a callable bond, the value of the embedded call option should be subtracted from the value of the straight bond.
作者: optiix 时间: 2012-3-30 16:29
Jori England, CFA candidate, is studying the value of callable bonds. She has the following information: a callable bond with a call option value calculated at 1.75 (prices are quoted as a percent of par) and a straight bond similar in all other aspects priced at 98.0. Which of the following choices is closest to what England calculates as the value for the callable bond?
To calculate the callable bond value, use the following formula: Value of callable bond = Value of straight bond – Call option value
Value of callable bond = 98.0 – 1.75 = 96.25.
Remember: The call option is of value to the issuer, not the holder.
作者: optiix 时间: 2012-3-30 16:29
Which of the following statements about embedded call options is most accurate? A)
| The call price acts as a floor on the value of a callable bond. |
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B)
| When yields rise, the value of a callable bond may not fall as much as a similar, straight bond. |
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C)
| The value of a callable bond is equal to the value of the straight bond component plus the value of the embedded call option. |
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The value of a callable bond is equal to the value of the straight bond component minus the value of the embedded call option. Remember, the call option benefits the issuer, not the investor. The call price acts as a ceiling on the value of a callable bond. The value of a callable bond will always be equal to or less than an otherwise identical non-callable bond.
作者: optiix 时间: 2012-3-30 16:30
Which of the following is least likely to be given as a reason that the prices of floating-rate bonds fluctuate from par?A)
| Coupon formulas with fixed-rate margins. |
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|
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Call risk pertains to callable bonds and is the risk of the bond issuer "calling the bond" when interest rates decrease. The issuer replaces the current bond with lower interest rate debt but the current bond holder usually loses due to having to replace their bond with a lower paying coupon bond. This has nothing to do with floating rate bonds. The rest of the choices are reasons why floating rate bonds fluctuate from par.
With a cap, when the market yield is above its capped coupon rate, a floating-rate security will trade at a discount. With fixed rate margins, if the creditworthiness of the firm improves, the floater is less risky and will trade at a premium to par.
作者: optiix 时间: 2012-3-30 16:31
Which of the following statements is NOT correct? All else equal, a floating-rate bond with: A)
| coupon reset dates every 3 months will have more price fluctuation than a bond with reset dates every 6 months. |
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B)
| a fixed-margin rate in the coupon formula will experience greater price fluctuation than a bond with an adjustable margin rate. |
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C)
| an interest rate cap will have more price fluctuation than a bond with no interest rate cap. |
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The more frequent the reset dates, the less the time lag that causes volatility. The greater the gap between reset dates, the greater the amount of price fluctuation.
Over the life of a bond, the required market margin is not constant. A fixed-margin coupon exposes the bond to more price fluctuations than an adjustable margin (as is the case with an extendible reset bond). Cap risk refers to when market interest rates rise to the point that the coupon on a floating-rate security hits the cap and the bond begins to behave like a fixed coupon bond, which has more price fluctuations.
作者: optiix 时间: 2012-3-30 16:32
The risk to a holder of a floating-rate bond that market rates will increase to the point where the bond behaves like a fixed-rate bond (increased price fluctuation) is known as:
This is the correct definition of cap risk. Cap risk occurs with floating-rate bonds that have a cap placed on how high the coupon rate can go.
Inflation risk refers to the risk that the rate of inflation will be higher than the investor anticipated, resulting in reduced purchasing power. An investor can reduce exposure to inflation risk by holding floating-rate bonds.
作者: optiix 时间: 2012-3-30 16:32
Which of the following statements about floating-rate bonds is NOT correct? A)
| Holding a floating-rate bond eliminates price fluctuations. |
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B)
| With a perfect, continuously resetting coupon rate, a floating-rate bond's value would always equal par. |
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C)
| A cap rate can increase the price volatility of a floating-rate bond. |
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Holding floating-rate bonds minimizes, but does not eliminate price fluctuations. The other statements are true.
作者: optiix 时间: 2012-3-30 16:32
Which of the following statements regarding floating-rate securities is most accurate? A)
| The longer the time until the next reset for a floating-rate security, the less interest rate risk it has. |
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B)
| A floating-rate security’s price will always equal par at its coupon reset date. |
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C)
| Prices of floating-rate securities are less sensitive to changes in market yields than the prices of fixed-rate securities. |
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Floating-rate securities have a coupon rate that resets periodically. The objective of this floating mechanism is to bring the coupon rate in line with the current market yield so that the bond sells at or near its par value, reducing interest rate risk compared to that of a fixed-rate security.
In general, the longer the time until the next reset, the greater the interest rate risk of the floating-rate security. The interest rate risk of a floating-rate security decreases as the reset date approaches because the coupon reset will return the price to par, as long as the margin above the reference rate accurately reflects the bond’s risk. If this fixed margin does not reflect changes in the issuer’s creditworthiness, the bond’s price may differ from par at its reset date.
作者: optiix 时间: 2012-3-30 16:33
An option-free bond has a market price and par value equal to $1,000. For small changes in the yield of this bond, its price will change one dollar for every basis point change in the yield. What is the duration of the bond?
Duration = [1001 − 999] / [2 × 1000 × 0.0001] = 10.
作者: optiix 时间: 2012-3-30 16:33
Which of the following bonds has the shortest duration? A bond with a: A)
| 10-year maturity, 10% coupon rate. |
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B)
| 20-year maturity, 6% coupon rate. |
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C)
| 10-year maturity, 6% coupon rate. |
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All else constant, a bond with a longer maturity will be more sensitive to changes in interest rates. All else constant, a bond with a lower coupon will have greater interest rate risk.
作者: optiix 时间: 2012-3-30 16:33
Assuming a flat term structure of interest rates of 5%, the duration of a zero-coupon bond with 5 years remaining to maturity is closest to:
The duration of a zero coupon bond is approximately equal to its time to maturity.
作者: optiix 时间: 2012-3-30 16:34
Which of the following statements about duration is CORRECT? A)
| A bond's percentage change in price and dollar change in price are both tied to the underlying price volatility. |
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B)
| The result of the formula for effective duration is for a 0.01% change in interest rates. |
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C)
| The formula for effective duration is: (price when yields fall − price when yields rise) / (initial price × change in yield expressed as a decimal). |
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The statement that a bond's percentage change in price and dollar change in price are both tied to the underlying price volatility is correct.
The effective duration formula result is for a 1.00% change in interest rates (100 basis points equals 1.00%, or 0.01 in decimal form). The denominator is multiplied by 2.
作者: optiix 时间: 2012-3-30 16:34
For coupon-paying bonds, duration and years to maturity: A)
| may be equal depending on the coupon rate. |
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C)
| are unequal with duration less than years to maturity. |
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For coupon paying bonds, duration is less than maturity.
Duration is approximately equal to the point in years where the investor receives half of the present value of the bond's cash flows. Since zero-coupon bonds only have one cash flow at maturity, the duration is approximately equal to maturity. Any coupon amount will shorten duration because some cash flow is received prior to maturity.
作者: optiix 时间: 2012-3-30 16:35
All else held equal, the duration of bonds selling at higher yields compared to bonds selling at lower yields will be: |
B)
| cannot be determined with the information given. |
|
|
Duration is inversely related to yield to maturity (YTM).The higher the YTM, the lower the duration. This is because the change in the bond's price (or present value) is inversely related to changes in interest rates. When market yields rise, the value (or cash flow) of a bond decreases without decreasing the time to maturity.
Duration is also a function of volatility (risk). Higher volatility (risk) = higher duration. A higher coupon bond has a lower duration relative to a similar bond with a lower coupon because the bond holder is getting more of their cash value sooner (because of the higher coupon). This lowers the overall risk of the bond resulting in a lower duration.
作者: optiix 时间: 2012-3-30 16:35
In December 2004, an investor purchases a zero-coupon bond issued in 1998 and maturing in December 2008. What is the bond's approximate duration?
For a zero-coupon bond duration is approximately equal to the number of years to maturity. Here, there are 4 years until maturity, so the effective duration is approximately equal to 4 years. We use the term approximately because this ignores the curvature of the price/yield curve.
作者: optiix 时间: 2012-3-30 16:35
Which of the following statements concerning bond duration is least accurate? Duration: A)
| decreases as the coupon increases. |
|
B)
| is the weighted-average maturity of the cash flows of the bond. |
|
C)
| increases as market yields rise. |
|
Duration decreases as market yields rise.
作者: optiix 时间: 2012-3-30 16:36
With an option-free zero-coupon bond the effective duration is: A)
| approximately equal to its years to maturity. |
|
B)
| unrelated to its time to maturity. |
|
C)
| approximately equal to the number of semiannual periods to maturity. |
|
For an option-free zero coupon bond, effective and modified duration will be almost identical and both will be approximately equal to the bond's years to maturity.
作者: optiix 时间: 2012-3-30 16:36
Why do bond portfolio managers use the concept of duration? A)
| It allows structuring a portfolio to take advantage of changes in credit quality. |
|
B)
| It assesses the time element of bonds in terms of both coupon and term to maturity. |
|
C)
| It enables direct comparisons between bond issues with different levels of risk. |
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Portfolio managers are very interested in a bond’s sensitivity to changes in interest rates. Bonds can be different in terms of maturity and coupon level, while both characteristics impact the change in the bond’s price given changes in interest rates. Duration is a measure that can assesses the time element of bonds in terms of both coupon and term to maturity.
作者: optiix 时间: 2012-3-30 16:36
Which one of the following bonds has the shortest duration? A)
| Zero-coupon, 13-year maturity. |
|
B)
| Zero-coupon, 10-year maturity. |
|
C)
| 8% coupon, 10-year maturity. |
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If bonds are identical except for maturity, and coupon, the one with the shortest maturity and highest coupon will have the shortest duration. The rationale for this is similar to that for price volatility. Duration is approximately equal to the point in years where the investor receives half of the present value of the bond's cash flows. Therefore, the earlier the cash flows are received, the shorter the duration.
The relationship of maturity to duration is direct - the shorter the time to maturity, the shorter the duration. A shorter-term bond pays its cash flows earlier than a longer-term bond, decreasing the duration. Here, one of the 10-year bonds will have the shortest duration.
The relationship of coupon to duration is indirect - the higher the coupon rate, the shorter the duration. A higher coupon bond pays higher annual cash flows than a lower coupon bond and thus has more influence on duration. Here, the 10-year bond with the highest coupon (8.00%) will have the shortest duration. Note: In addition to having the highest price volatility, zero-coupon bonds have the longest duration (at approximately equal to maturity). This is because zero coupon bonds pay all cash flows in one lump sum at maturity.
作者: optiix 时间: 2012-3-30 16:37
All other things being equal, which one of the following bonds has the greatest volatility?
This question is asking: given a change in yield, which of the bonds will exhibit the greatest price change? Of the four choices, the bond with the longest maturity and lowest coupon will have the greatest price volatility.
All else equal, the bond with the longer term to maturity is more sensitive to changes in interest rates. Cash flows that are further into the future are discounted more than near-term cash flows. Here, this means that one of the 20-year bonds will have the highest volatility. Similar reasoning applies to the coupon rate. A lower coupon bond delivers more of its total cash flow (the bond's par value) at maturity than a higher coupon bond. All else equal, a bond with a lower coupon than another will exhibit greater price volatility. Here, this means that of the 20-year bonds, the one with the 10% coupon rate will exhibit greater price volatility than the bond with the 15% coupon.
作者: optiix 时间: 2012-3-30 16:37
Which set of conditions will result in a bond with the greatest volatility? A)
| A high coupon and a short maturity. |
|
B)
| A low coupon and a long maturity. |
|
C)
| A high coupon and a long maturity. |
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If bonds are identical except for maturity and coupon, the one with the longest maturity and lowest coupon will have the greatest volatility.
The relationship of maturity to volatility is direct - the longer the time to maturity, the greater the volatility. A longer-term bond pays its cash flows later than a shorter-term bond, increasing the volatility. This is because a bond’s price is determined by discounting the value of the cash flows. A longer-term bond pays its cash flows later than a shorter-term bond, and longer-term cash flows are discounted more heavily.
The relationship of coupon to volatility is indirect - the lower the coupon rate, the greater the volatility. This is because a bond’s price is determined by discounting the value of the cash flows. A lower coupon bond pays less cash flows over the bond's life and more at maturity than a higher coupon bond. As noted above, longer-term cash flows are discounted more heavily.
作者: optiix 时间: 2012-3-30 16:37
Duration measures the: A)
| length of time until a bond matures. |
|
B)
| timing of cash flows weighted by the proportionate value of each flow's present value. |
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C)
| cash flows weighted by the timing of the cash flows. |
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The sensitivity of a bond’s price to changes in yield is known as a bond’s effective duration. Macaulay’s duration is calculated by the timing of cash flows weighted by the proportionate value of each flow’s present value.
作者: optiix 时间: 2012-3-30 16:38
Which of the following statements about duration of a bond is least accurate? A)
| The dollar change in price for a 1% change in yield is approximately equal to the product of the duration and the current value of the bond divided by 100. |
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B)
| The duration of a floater is equal to the time to the next reset date. |
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C)
| If a bond has an effective duration of 7.5, it means that a 1% change in rates will result in a 7.5% change in price. |
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Because of convexity, it will be approximately a 7.5% change in price, not an actual 7.5% change in price. The readings are very explicit about this distinction.
作者: optiix 时间: 2012-3-30 16:38
Duration of a bond normally increases with an increase in:
Duration is directly related to maturity and inversely related to the coupon rate and yield to maturity (YTM). Duration is approximately equal to the point in years where the investor receives half of the present value of the bond's cash flows. Therefore, the later the cash flows are received, the greater the duration.
The longer the time to maturity, the greater the duration (and vice versa). A longer-term bond pays its cash flows later than a shorter-term bond, increasing the duration.The lower the coupon rate, the greater the duration (and vice versa). A lower coupon bond pays lower annual cash flows than a higher-coupon bond and thus has less influence on duration.The lower the YTM, the higher the duration. This is because the bond's price (or present value) is inversely related to interest rates. When market yields fall, the value (or cash flow) of a bond increases without increasing the time to maturity.
作者: optiix 时间: 2012-3-30 16:38
Portfolio duration is best described as the: A)
| sensitivity of a portfolio’s value to changes in the term structure of interest rates. |
|
B)
| sensitivity of a portfolio’s value to equal changes in yield for all the bonds in the portfolio. |
|
C)
| arithmetic mean of the durations of each bond in a portfolio. |
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Portfolio duration is a measure of a portfolio’s interest rate risk. It measures the sensitivity of the portfolio’s value to an equal change in yield for all the bonds in the portfolio. It can be calculated as the weighted average of the individual bond durations using the proportions of the total portfolio value represented by each of the bonds. Portfolio duration does not capture the effect of changes in the yield curve (term structure).
作者: optiix 时间: 2012-3-30 16:39
Which of the following statements about the yield curve is CORRECT? A)
| Parallel shifts in the yield curve are not of concern to bond investors. |
|
B)
| If long-term rates are low, the present value of cash flows far into the future will be low,and the bond's value will be low. |
|
C)
| In a typical upward sloping yield curve, short and intermediate term rates are lower than long term rates. |
|
The statement, "If long-term rates are low, the present value of cash flows far into the future will be low,and the bond’s value will be low," should read, "If long-term rates are low, the present value of cash flows far into the future will be high,and the bond’s value will be high." The value of a bond is comprised of discounted cash flows, and a lower discount rate translates to higher cash flows. Any shift in the yield curve creates uncertainty and is of concern to bond investors.
作者: optiix 时间: 2012-3-30 16:39
The structure of interest rates results from all the following EXCEPT: A)
| assuming that individual discount rates do not change by the same amount. |
|
B)
| creating the yield curve by plotting term to maturity against the coupon rate. |
|
C)
| viewing each bond coupon payment as a separate zero coupon bond. |
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The yield curve plots term to maturity and yield to maturity. The other choices are true.
作者: optiix 时间: 2012-3-30 16:39
Which of the following statements about the yield curve is CORRECT? A)
| A nonparallel shift occurs when rates change by the same number of basis points for all maturities. |
|
B)
| A nonparallel shift is more common than a parallel shift. |
|
C)
| The yield curve usually has a nonzero slope because rates change by approximately the same number of basis points across maturities. |
|
The definitions for parallel and nonparallel shifts are reversed. The first part of the statement that begins, "The yield curve usually has a nonzero slope,…" is correct. However, the second part is incorrect – the slope occurs because rates change by different basis points across maturities.
作者: optiix 时间: 2012-3-30 16:40
Which of the following statements is NOT correct? Compared to a callable bond, a noncallable bond: A)
| is more attractive to an investor concerned with reinvestment risk. |
|
B)
| has more predictable cash flows. |
|
C)
| provides a higher yield. |
|
When compared to a callable bond, the yield on a noncallable bond is less. With a noncallable bond, the issuer does not have to compensate the investor for call risk/cash flow uncertainty with any premium.
The other choices are correct. Call risk is the combination of cash flow uncertainty and reinvestment risk. When a bond is called, the investor faces a disruption in cash flow and a reduced rate of return.
作者: optiix 时间: 2012-3-30 16:40
Price compression: A)
| occurs when a bond's cap and floor are set close together. |
|
B)
| occurs when demand for a bond is high near the first call date. |
|
C)
| reduces the potential for price appreciation. |
|
When a bond has a call provision, the potential for price appreciation is reduced, because the call caps the price of the bond near the call price, even if interest rates fall considerably. It is unlikely that investors would pay a price that exceeds the call price.
作者: optiix 时间: 2012-3-30 16:40
Which of the following statements about callable bonds is CORRECT? A)
| As interest rates fall, the value of a callable bond will exceed that of a similar straight bond. |
|
B)
| When yields rise, the value of a callable bond is less sensitive and will exhibit less of a price change than a noncallable bond. |
|
C)
| As interest rates decrease, the value to the investor of the call option increases. |
|
When yields rise, the value of callable bond may not fall as much as that of a similar straight bond because of the embedded call option feature. With a decrease in interest rates, the value of a callable bond can increase to only approximately the call value (the call price serves as a cap or “ceiling.”). Straight bonds will continue to exhibit the inverse relationship between yields and prices, as there is no “ceiling” call price.
The statement that begins, “As interest rates decrease…,” should continue, “.. the value to the issuer of the call option increases.” As interest rates decrease, the issuer values the call option more because the company has the potential to call the bond and replace existing debt with lower-coupon (and thus lower cost) debt.
作者: optiix 时间: 2012-3-30 16:41
Simone Girau holds a callable bond and Chi Rigazio holds a putable bond. Which of the following statements about the two investors is most accurate? A)
| Girau's bond has less potential for price appreciation. |
|
B)
| As the yield volatility increases, the value of both Girau's bond and the underlying option increases. |
|
C)
| Both investors calculate the value of the bond held by adding the value of the option to the value of a similar straight bond. |
|
When a bond has a call provision, the potential for price appreciation is reduced, because the call caps the price of the bond near the call price. Even if interest rates fall considerably, it is unlikely that investors would pay a price that exceeds the call price.
The other statements are false. To calculate the value of a putable bond, it is correct to add the option value to the value of a similar straight bond. However, to calculate the callable bond value, subtract the option value from that of a similar straight bond. As a result, when yield volatility increases (thus increasing the option value), the value of a callable bond decreases and the value of a putable bond increases. A call option does benefit the issuer, but a put option benefits the holder. Embedded options (puts and calls) increase in value when volatility increases.
作者: jawz 时间: 2012-3-30 16:42
Which of the following statements is CORRECT? A)
| A bond with high reinvestment risk also has high price, or interest rate risk. |
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B)
| Mortgage backed and asset backed securities have lower reinvestment risk than straight coupon bonds. |
|
C)
| The prepayment option on a mortgage loan benefits the issuer. |
|
In the case of a mortgage or auto loan, the issuer is the borrower and is the party that benefits from the prepayment option. In a declining interest rate environment, the issuer can retire higher cost debt and replace it with lower cost debt (i.e. refinancing a mortgage). When an issuer (borrower) calls, or prepays, the lending institution (the security holder) faces reinvestment risk because it must reinvest the proceeds at lower rates.
Mortgage backed and other asset backed securities have high reinvestment (or prepayment) risk because in addition to cash flows from periodic interest payments (like bond coupons), these securities have repayment of principal. The lower the interest rate, the higher chance that the loans underlying these assets will repay in full due to refinancings. A bond, such as a zero coupon bond, can have high interest rate risk (because its single cash flow subjects it to the full amount of discounting when interest rates change) and low reinvestment risk (the single cash flow minimizes prepayment risk).
作者: jawz 时间: 2012-3-30 16:43
Consider three bonds that are similar in all features except those shown. The bond with the greatest reinvestment risk is: |
B)
| 15% coupon, non-callable. |
|
|
Reinvestment risk is higher with high-coupon bonds because a larger proportion of their realized yield depends on reinvestment of the coupon interest payments. Callable bonds have more reinvestment risk than noncallable bonds, since their principal may be repaid earlier than the stated maturity date.
作者: jawz 时间: 2012-3-30 16:43
Which of the following statements concerning reinvestment risk is most accurate? A)
| Reinvestment risk is increased if there are prepayment provisions on the bond. |
|
B)
| Reinvestment risk is highest for zero-coupon bonds. |
|
C)
| Lower coupon bonds have more reinvestment risk. |
|
Reinvestment risk is increased if there are prepayment provisions that return a large amount of principal to the lender at a time when interest rates have declined. Note that the other statements are false. Reinvestment risk is lowest for zero coupon bonds – a corollary of this statement is that the lower the coupon, the less reinvestment risk there is for the bond.
作者: jawz 时间: 2012-3-30 16:43
Which of the following choices correctly places callable bonds, straight coupon bonds, mortgage-backed securities, and zero-coupon bonds in order from the type of security with the least reinvestment risk to the one with the most reinvestment risk? A)
| zero-coupon bonds, mortgage-backed securities, straight coupon bonds, callable bonds. |
|
B)
| callable bonds, straight coupon bonds, zero-coupon bonds, mortgage-backed securities. |
|
C)
| zero-coupon bonds, straight coupon bonds, callable bonds, mortgage-backed securities. |
|
Of the three choices, zero-coupon bonds have the least reinvestment risk. An investor can nearly eliminate reinvestment risk by holding a noncallable zero-coupon bond until maturity because zero-coupon bonds deliver all cash flows in one lump sum at maturity.
Straight coupon bonds (no prepayment or other embedded options) have the next most reinvestment risk because of the periodic coupon payments. If interest rates decline, the bondholder will have to reinvest the coupons at a rate lower than that required to earn the original expected yield-to-maturity.
Callable bonds have more reinvestment risk because the right to prepay principal compounds reinvestment risk. A call option is one form of prepayment right that benefits the issuer, or borrower.
Mortgage backed and other asset backed securities have the most prepayment risk because in addition to cash flows from periodic interest payments (bond coupons, for example), these securities have periodic repayment of principal. The lower the interest rate, the higher chance that the loans underlying these assets will repay in full.
作者: jawz 时间: 2012-3-30 16:44
Which of the following statements relating to reinvestment risk for bonds is CORRECT? A)
| Long-term bonds should be purchased if the investor anticipates higher reinvestment rates. |
|
B)
| Unless the reinvestment rate equals the yield to maturity, the holding period return will be less than the yield to maturity. |
|
C)
| Zero coupon bonds have no reinvestment risk over their term. |
|
This statement is correct only if the investor holds the bond until maturity. Reinvestment risk means that a bond investor risks having to reinvest bond cash flows (both coupon and principal) at a rate lower than the promised yield. Reinvestment risk increases with longer maturities and higher coupons, and decreases for shorter maturities and lower coupons. While a bond investor can eliminate price risk by holding a bond until maturity, he usually cannot eliminate bond reinvestment risk. One exception is zero-coupon bonds, since these bonds deliver payments in one lump sum at maturity. There are no payments over the life to reinvest.
The statement, "Long-term bonds should be purchased if the investor anticipates higher reinvestment rates," should read, "Short-term bonds...".If an investor expects interest rates to rise, he would want a bond with a shorter maturity so that he received his cash flows sooner and could reinvest at the higher rate. Also, there is less prepayment risk with shorter maturities.
The statement that begins, "Unless the reinvestment rate...," is partially true. However, the holding period return (covered in a later LOS) could be less or greater than the original yield to maturity (YTM). Over the investor's holding period, interest rates are likely to fluctuate both up and down; at some points the investor will reinvest at a higher rate than the original YTM and sometimes he will reinvest at a lower rate.
作者: jawz 时间: 2012-3-30 16:44
The reinvestment assumption is less important if the coupon and term to maturity are:
This question is asking: when is the risk of a bond investor having to reinvest bond cash flows (both coupon and principal) at a rate lower than the promised yield? Reinvestment risk increases with longer maturities and higher coupons, and decreases for shorter maturities and lower coupons. Reinvestment risk is important because the yield-to-maturity (YTM) calculation for a bond assumes that the investor can reinvest cash flows at exactly the coupon rate. (Note: YTM calculations are discussed in a later LOS.)
All else equal, the bond with the shorter term to maturity is less sensitive to changes in interest rates and prepayment rates. Here, this means that a shorter-term bond has lower reinvestment risk than a longer-term bond.
All else equal, a lower coupon rate means that it is more likely that the investor can reinvest the coupon cash flow at near or equal to the yield-to-maturity. Here, this means that a lower coupon bond has less reinvestment risk.
In summary, reinvestment risk is least important with the combination of shorter maturity and lower coupon rate.
作者: jawz 时间: 2012-3-30 16:44
Kyle Barnes, CFA, is meeting his friend, Lita Rombach, about possible bond investments. Rombach is concerned about reinvestment risk. Which of the following statements about Rombach is CORRECT? Rombach: A)
| will prefer a noncallable bond to a callable bond. |
|
B)
| will prefer a higher coupon bond to a lower coupon bond. |
|
C)
| need only be concerned about reinvestment risk on coupon payments. |
|
A noncallable bond reduces reinvestment risk by reducing the risk of repayment.
With her primary concern being reinvestment risk, Romach will prefer a lower coupon bond to a higher coupon bond. Reinvestment risk applies to all bond cash flows, not just the coupon payments.
作者: jawz 时间: 2012-3-30 16:45
Silhouette Enterprises must make a balloon loan payment of $1,000,000 in 3 years. The firm’s treasurer wants to purchase a bond that will provide funds for repayment and minimize reinvestment risk. Assume the company has the following three investment alternatives (all zero coupon bonds with face values of $1,000,000). Market rates are at 8.0%. All bonds are noncallable and are otherwise similar except as noted. Which bond best meets the treasurer’s requirements?A)
| A 3-year, zero coupon bond priced to yield 8.0%. |
|
B)
| A 4-year, zero coupon bond priced to yield 8.5%. |
|
C)
| A 2-year, zero-coupon bond priced to yield 9.0%. |
|
Among the zero-coupon bonds, the one that best matches the loan’s maturity will minimize reinvestment risk. The treasurer will thus prefer the 3-year, zero-coupon bond. If he purchased the 4-year zero-coupon bond, he would have to sell the bond prior to maturity to pay off the loan and would face price risk. The 2-year zero-coupon bond is attractive because of the higher yield. However, the bond matures one year before the loan is due and would expose the firm to reinvestment risk.
作者: jawz 时间: 2012-3-30 16:45
Which of the following statements about reinvestment risk is least accurate? A)
| A bond's yield calculation assumes that coupon cash flows and principal can be reinvested at the computed yield to maturity. |
|
B)
| A bond investor can eliminate reinvestment risk by holding a coupon bond until maturity. |
|
C)
| An investor concerned about reinvestment risk is most concerned with a decrease in interest rates. |
|
The key word here is coupon bond. While an investor in a fixed-coupon bond can usually eliminate price risk by holding a bond until maturity, the same is not true for reinvestment risk. The receipt of periodic coupons exposes the investor to the risk that he will have to invest the coupons at a lower rate, thus negatively impacting his holding period return. An investor can greatly decrease reinvestment risk by holding a zero-coupon, noncallable bond that is not subject to other prepayments (or embedded options). Zero-coupon bonds deliver all cash flows in one lump sum at maturity.
The other statements about bond yield calculations and reinvestment risks are correct.
作者: jawz 时间: 2012-3-30 16:45
An investor holds a 20-year, semi-annual 8.00% coupon Treasury bond issued at par. Market interest rates are currently at 6.50%. The bond is noncallable. A coupon payment is due this week. Which of the following choices best represents the type of risk the investor faces?
Reinvestment risk is the risk that if rates fall, cash flows will be reinvested at lower rates, resulting in a holding return lower than that expected at purchase. Here, the investor will likely have to reinvest the coupon at the lower market interest rate, negatively impacting his holding period return.
Prepayment risk (and call risk) is the risk that the issuer will repay principal prior to maturity. Prepayments are most likely in a declining interest rate environment because it is cheaper to issue replacement debt. Here, the bond is a Treasury and is noncallable, so the investor can eliminate prepayment risk by holding the bond until maturity. Credit risk is the risk that the issuer will be unable to make coupon or principal payments as scheduled. Any change in the timing of the receipt of cash flows affects the bond’s holding period return. Credit risk is not a concern with Treasury securities.
作者: jawz 时间: 2012-3-30 16:46
The risk that an investor will earn less than the quoted yield-to-maturity on a fixed-coupon bond due to a decrease in interest rates is known as:
Reinvestment risk is the risk that if rates fall, cash flows will be reinvested at lower rates, resulting in a holding return lower than that expected at purchase.
Prepayment risk (and call risk) is the risk that the issuer will repay principal prior to maturity. Prepayments are most likely to occur in a declining interest rate environment because it is cheaper to issue replacement debt. Event risk means that the issuer could face a single event or circumstance that would affect its ability to service/repay the debt. For example, a corporation could suffer an industrial accident.
作者: jawz 时间: 2012-3-30 16:46
When determining credit risk spread, the benchmark security is most likely a(n): |
B)
| high-yield corporate bond. |
|
|
The credit risk spread is measured in relation to a default-free security. Of the choices above, the security with the least chance of default is the Treasury bond. The AA rated bond is high quality, but not the highest quality (which would have an AAA rating). The high-yield corporate bond is an unlikely candidate for the benchmark security because high yield usually denotes high risk.
作者: jawz 时间: 2012-3-30 16:47
Benjamin Zoeller and Tara McGonigal are preparing for the Level I CFA examination. Zoeller is studying credit spread risk. McGonigal is farther along in her studies, but has forgotten how to determine the default free rate if given the yield on a bond rated BBB+ of 9.50% and a risk premium of 3.00%. What does Zoeller tell her to use for the default free rate?
The formula for credit spread risk (or the yield on a risky asset) is:
YieldRisky = YieldRF + Risk Premium, where RF = default − free rate.
Rearranging this formula results in: YieldRF = YieldRisky – Risk Premium, or YieldRF = 9.50% – 3.00% = 6.50%.
作者: jawz 时间: 2012-3-30 16:47
Suppose that a corporate bond and a government bond have equivalent characteristics. They both have a coupon rate of 6% paid annually and have two years remaining to maturity. Assuming a flat government term structure of 7% which of the following is a possible price of the corporate bond?
Since the corporate bond involves credit risk and the government bond doesn't. The corporate bond price has to be less than the government bond price which is computed as follows:
Government Bond Price = 6 / 1.07 + 106 / 1.072 = 98.19
作者: jawz 时间: 2012-3-30 16:47
Which of the following will most likely have the least impact on a corporate bond rating? The: A)
| issue's indenture provisions. |
|
B)
| issuing company's volume of sales. |
|
C)
| issuing company's debt burden. |
|
The size of the issuing firm, represented by the amount of sales, will play a role in the financial stability of the firm. However, the other choices, leverage and indenture provisions, are more directly related to the bond’s rating. Smaller firms are not likely to issue bonds and issuers are typically larger firms overall.
作者: jawz 时间: 2012-3-30 16:48
With respect to bond investing, reinvestment risk is a very important component of what other type of risk?
Call risk is composed of three components: the unpredictability of the cash flows, the compression of the bond’s price, and the high probability that when the bond is called the investor will be faced with less attractive investment opportunities. This latter risk is reinvestment risk. Reinvestment risk is not a directly related to any of the other choices.
作者: jawz 时间: 2012-3-30 16:48
When planning to hold a coupon-paying Treasury bond until maturity, which of the following types of risk would be the most important?
Since it is a Treasury bond, default risk is not relevant. Interest rate risk is not important because the investor plans to hold the bond until maturity. Reinvestment risk is the most important. The investor will have to worry about the rates at which he/she will be able to reinvest the coupons over the life of the bond and the principal upon maturity.
作者: jawz 时间: 2012-3-30 16:48
Credit risk is measured in several ways. The yield differential above the return on a benchmark security measures the:
The yield differential above the return on a benchmark security measures the credit spread risk. Credit spread risk is also known as the risk premium or spread.
作者: jawz 时间: 2012-3-30 16:48
Which of the following statements is CORRECT? A)
| When a rating agency downgrades a security, the bond's price usually falls. |
|
B)
| Default risk is important because if a bond issuer defaults, the bondholder likely loses his entire investment. |
|
C)
| Technical default usually refers to the issuer's failure to make interest or principal payments as scheduled in the indenture. |
|
The market will likely demand a higher yield from the downgraded bond (the risk premium has increased) and thus the price will likely fall.
Technical default usually refers to an issuer’s violation of bond covenants, such as debt ratios, rather than the failure to pay interest or principal. In the event of default, the holder (lender) may recover some or all of the investment through legal action or negotiation. The percentage recovered is known as the recovery rate.
作者: jawz 时间: 2012-3-30 16:49
Which of the following investors is least likely to have liquidity risk concerns? A: A)
| corporate bond investor who intends to hold securities until maturity. |
|
B)
| financial institution heavily involved in the repurchase market. |
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C)
| trader who invests exclusively in Treasury bonds. |
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Treasury securities are the most liquid of the investments mentioned.
The repurchase market is short term in nature and the collateral is marked-to-market daily. Thus, the need to quickly convert securities to cash (and at approximately market value) is very important. Emerging markets are usually less liquid than established markets, one reason being the small trading volumes. Even if an investor intends to hold the security to maturity, liquidity risk impacts portfolios when marking to market and through changes in investor tastes and preferences over time. For example, liquidity is important to institutional investors that must determine market values for net asset values (NAVs).
作者: jawz 时间: 2012-3-30 16:49
Which of the following statements regarding liquidity risk is NOT correct? A)
| Liquidity risk is not important to an investor who intends to hold a security until maturity. |
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B)
| Emerging markets typically have more liquidity risk than established markets. |
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C)
| The bid-ask spread is one measurement of liquidity risk. |
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Even if an investor intends to hold securities to maturity, liquidity risk impacts portfolios when marking to market and through changes in investor tastes and preferences over time. For example, liquidity is important to institutional investors that must determine market values for net asset values (NAVs) and to dealers in the repurchase market for collateral valuation.
A narrow bid-ask spread indicates a liquid asset, while a wide bid-ask spread indicates an illiquid asset. For example, the spreads on recently issued Treasury securities are often only a few basis points. Emerging markets are usually less liquid than established markets, one reason being the small trading volumes.
作者: jawz 时间: 2012-3-30 16:50
Which of the following statements does NOT describe a characteristic of an illiquid asset or market? A)
| Large block trades that do not materially affect prices. |
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B)
| Small trading volumes. |
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In a liquid market with large trading volumes, large block trades should not affect prices. The other choices are characteristics of illiquid markets or assets.
作者: jawz 时间: 2012-3-30 16:50
Which of the following assets is the least liquid? A)
| Foreign exchange futures contract. |
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B)
| On-the-run Treasury security. |
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All other choices are considered highly liquid assets. On-the-run Treasuries are recently issued and are often more liquid than older issues.
作者: jawz 时间: 2012-3-30 16:50
Which of the following statements about liquidity risk is least accurate? A)
| A lack of liquidity may make it difficult to determine the value of a security. |
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B)
| Liquidity risk and the bid-ask spread are not relevant to an investor who is planning to hold a security to maturity. |
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C)
| The bid-ask spread is an indication of the liquidity of a security. |
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Even if the investor plans to hold the security until maturity rather than trade it, poor liquidity can have adverse consequences stemming from the need to periodically mark securities to market. When a security has little liquidity, the variation in dealers’ bid prices (or a lack of bids) makes valuation more difficult. Bid-ask spreads tend to be narrower for more liquid securities and wider for less liquid securities.
作者: jawz 时间: 2012-3-30 16:51
Assume there are two investors, one in the U.S. and one in Switzerland. In the context of bond investments, appreciation in the Swiss franc benefits the: A)
| U.S. investor holding Swiss bonds. |
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B)
| U.S. investor holding U.S. bonds. |
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C)
| Swiss investor holding U.S. bonds. |
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The appreciation of the foreign currency (Swiss franc) benefits domestic investors (U.S. citizens) who own foreign (Swiss) bonds. When the Swiss franc appreciates, each Swiss franc buys more of the U.S. dollar than before. Here, the U.S. investor gains by owning foreign bonds because the investor realizes not only the return from the bond but also a gain from the foreign currency appreciation. The return realized by the Swiss investor holding U.S. bonds is decreased by the depreciation of the U.S. dollar against the Swiss franc.
作者: jawz 时间: 2012-3-30 16:51
Which of the following statements about currency risk is most accurate? Generally: A)
| if the foreign currency appreciates, the foreign cash flow will be worth less for the domestic investor. |
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B)
| appreciation of the foreign currency is good for domestic investors who buy foreign securities. |
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C)
| if the home currency appreciates against the foreign currency, each foreign currency unit will be worth more in terms of the home currency. |
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If the home currency appreciates against the foreign (i.e., payment) currency, each foreign currency unit will be worth less in terms of the home currency. If the foreign currency appreciates, a given foreign cash flow will be worth more units of the home currency, thereby benefiting the domestic investor holding foreign securities.
作者: jawz 时间: 2012-3-30 16:51
Which of the following statements concerning the exchange rate risk of investing in foreign bonds is most accurate? If the foreign currency: A)
| appreciates, the bond's coupon increases. |
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B)
| depreciates, the bond's coupon payments will turn into more U.S. dollars. |
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C)
| depreciates, bond investors lose, all else equal. |
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If the foreign currency depreciates, bond investors lose, all else equal. This occurs because the bond’s coupon payments and principal will convert to fewer U.S. dollars.
作者: jawz 时间: 2012-3-30 16:52
Which of the following statements is NOT correct? A)
| Exchange-rate risk may benefit a bond investor. |
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B)
| The depreciation of foreign currency benefits domestic investors who buy foreign securities. |
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C)
| An investor who purchases a foreign bond gains the most when both the asset and the foreign currency appreciate in value. |
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This statement should read, "The appreciation of foreign currency benefits domestic investors who buy foreign securities." The other choices are correct. Exchange rate risk creates uncertainty for the investor, but is not always bad for the investor. If a domestic investor purchased a foreign currency denominated bond, appreciation in the foreign currency would benefit the investor.
作者: jawz 时间: 2012-3-30 16:52
While serving as visiting conductor at the University of Edinburgh, U.S. Citizen William Golson purchases a 9.0% annual coupon bond denominated in the local currency for 93.0. One year later, before his return to the U.S., he sells the bond for 99.5. Using a holding period return formula he remembers from his undergraduate studies, he calculates his return at 16.7%. On the flight home, he is seated next to Kristin Meyer, CFA. She is puzzled because she has heard that similar investments yielded negative returns over the same time period. After consulting her financial newspaper, she recalculates Golson’s return at a disappointing negative 5.2%.
Assuming Meyer is correct, which of the following statements is the most likely reason for the difference in the calculated returns? Golson:A)
| forgot to include the impact of foreign currency depreciation in relation to the dollar. |
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B)
| forgot to include the impact of foreign currency appreciation in relation to the dollar. |
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C)
| omitted the impact of inflation. |
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Golson most likely forgot to take into account the impact of the percentage change in the dollar value of the foreign currency. Here, since the correct return (calculated by Meyer) is lower than that calculated by Golson (who omitted the impact of foreign exchange), the foreign currency depreciated in relation to the dollar. The appreciation in the bond value was not enough to offset the currency depreciation, and the total return in dollar terms was negative. Calculating the total dollar return on a bond is discussed in more detail later in Study Session 18.
作者: jawz 时间: 2012-3-30 16:52
While working abroad, U.S. citizen Dirk Senik purchases a foreign bond with an annual coupon of 7.5% for 95.5. One year later, the exchange rate between the dollar and the foreign currency remains unchanged and he sells the bond for 97.25, resulting in a holding period return of 9.7%. If the foreign currency had depreciated in relation to the dollar, Senik’s return would be:
The return on a foreign bond is a combination of the return on the bond and the movement in the foreign currency. In the base case, the movement in the foreign security was 0 and thus the return was just the holding period return on the bond. If the foreign currency depreciates, the return will be lowered because the investor will lose upon conversion to the dollar.
作者: burning0spear 时间: 2012-3-30 16:53
Which of the following investors is least susceptible to inflation risk? A)
| The holder of a 15-year bond with a coupon formula equal to the U.S. prime rate plus 3.25%. |
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B)
| An individual with a 5 year certificate of deposit at a local financial institution. |
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C)
| A financial institution with assets concentrated in fixed-rate mortgages. |
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A 15-year bond with a coupon formula equal to the U.S. prime rate plus 3.25% is an example of a floating rate bond. The holder of an adjustable rate asset is impacted less by inflation than the holder of a fixed-rate asset because the increased cash flow (from the higher coupon payments when the base rate increases) at least partially offsets the decreased purchasing power caused by inflation.
The other two choices are examples of investors more susceptible to inflation - those who hold long-term contracts in which they are to receive a fixed payment.
作者: burning0spear 时间: 2012-3-30 16:54
Which of the following statements about inflation risk is NOT correct? A)
| Treasury securities are considered immune to inflation and liquidity risk. |
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B)
| The short term inflation premium is less than the long term premium. |
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C)
| The real return on a fixed coupon bond is variable. |
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The statement Treasury securities are considered immune to inflation and liquidity risk is partially true – Treasury securities are immune to liquidity risk, but fixed-coupon Treasury securities have high inflation risk and generally low real returns.
The other choices are correct. The inflation premium is less in the short term because investors are better able to predict inflation in the short term – inflation risk increases as time increases. (Investors want to be compensated for this uncertainty.) An investor’s real return is not fixed- even though an investor may hold a fixed-rate coupon bond, the real return depends on a variable – inflation. Higher inflation rates result in a reduction of the purchasing power of bond payments.
作者: burning0spear 时间: 2012-3-30 16:54
One year ago, Makato Omura purchased a 6.50% fixed coupon bond for 98.50. Recently, she sold the bond for 99.25 and calculated her return at 7.4%. Her friend, Takanino Takemiya, CFA, reminds Omura that this is the nominal return and that to calculate the real return, she needs to factor in the inflation rate over the holding period. If the price index for the current year is 118.5 and the price index one year ago was 115.9, Omura’s real return is closest to:
Omura’s real return is approximated by subtracting the inflation rate from the calculated (nominal) return. The inflation rate is calculated using the formula:Inflation = (Price Indexthis year – Price Indexlast year) / Price Indexlast year
Here, inflation = (118.5 – 115.9) / 115.9 = 0.0224, or approximately 2.2%.
Thus, the real return = 7.4% - 2.2% = 5.2%.
作者: burning0spear 时间: 2012-3-30 16:55
David Korotkin, CFA and a broker at an investment bank, has a client who is very concerned about maintaining purchasing power over the next year. The investor is conservative, and to date has been pleased with a consistent return of 8.00%. The bank’s research department has estimated next year’s inflation rate at 2.0%. The client specifically wants to invest in a fixed-coupon bond. Which of the following statements is most correct? If Korotkin purchases a bond with a 10.00% coupon, the client: A)
| will not lose purchasing power. |
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B)
| may lose purchasing power. |
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C)
| will realize a real gain. |
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Investors want to be compensated for the inflation they expect plus for the risk that inflation will increase during the term of the investment. Here, the bank’s estimated inflation rate is just that – an estimate. Thus, we cannot say for certain that the investor will not lose purchasing power. Inflation risk introduces uncertainty to the investment process.
作者: burning0spear 时间: 2012-3-30 16:55
Simone Girard, CFA candidate, is studying yield volatility and the value of callable bonds. She has the following information: a callable bond with a call option value calculated at 1.25 (prices are quoted as a percent of par) and a straight bond similar in all other aspects priced at 98.5. Girard also wants to determine how the bond’s value will change if yield volatility increases. Which of the following choices is closest to what Girard calculates as the value for the callable bond and correctly describes the bond’s price behavior as yield volatility increases? A)
| 97.25, price decreases. |
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B)
| 97.25, price increases. |
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C)
| 99.75, price decreases. |
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To calculate the callable bond value, use the following formula:
Value of callable bond = Value of straight bond – Call option value
Value of callable bond = 98.5 – 1.25 = 97.25.
Remember: The call option is subtracted from the bond value because the call option is of value to the issuer, not the holder.
As yield volatility increases, the value of the embedded option increases. The formula above shows that for a callable bond, an increase in the option value results in a decreased bond value.
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