LOS d: Discuss the primary reasons for secondary market trading, including yield/spread pickup trades, credit-upside trades, credit-defense trades, new issue swaps, sector-rotation trades, yield curve-adjustment trades, structure trades, and cash flow reinvestment.

Q1. Which of the following statements about the rationale for trading in the secondary bond market is FALSE?

A)   The popularity of credit-defense trades is not related to expected levels of economic uncertainty.

B)   Altering the duration of a portfolio because of anticipated yield curve changes is labeled a curve adjustment trade.

C)   The reason to engage in a sector-rotation trade is to shift out of a sector that is expected to underperform on a total return basis, and buy into a sector that is expected to outperform in total return.

Q2. Which of the following is the best rationale for purchasing an issue in the secondary market?

A)   Expectations of an upgrade in an issuer's credit quality.

B)   High-default rates in a particular sector.

C)   Increasing credit risk for a particular bond.

Q3. Estimates are that more than 50% of all secondary bond trading is due to which type of trade?

A)   Yield/spread pickup.

B)   Curve adjustment.

C)   New issue swaps.

Q4. Expectations that an issue will experience a quality upgrade that is not already reflected in the current spread could result in which type of trade?

A)   Sector rotation.

B)   Credit defense.

C)   Credit-upside.

Q5. On-the-run Treasuries are frequently perceived to have superior liquidity. Based on this rational, many bond managers engage in:

A)   curve adjustment trades.

B)   new issue swaps.

C)   credit defense trades.

LOS d: Discuss the primary reasons for secondary market trading, including yield/spread pickup trades, credit-upside trades, credit-defense trades, new issue swaps, sector-rotation trades, yield curve-adjustment trades, structure trades, and cash flow reinvestment. fficeffice" />

Q1. Which of the following statements about the rationale for trading in the secondary bond market is FALSE?

A)   The popularity of credit-defense trades is not related to expected levels of economic uncertainty.

B)   Altering the duration of a portfolio because of anticipated yield curve changes is labeled a curve adjustment trade.

C)   The reason to engage in a sector-rotation trade is to shift out of a sector that is expected to underperform on a total return basis, and buy into a sector that is expected to outperform in total return.

Correct answer is A)

Credit-defense trades result from a bond manager’s desire to reduce the portfolio’s exposure to expected credit downgrades. As such, during periods of anticipated economic uncertainty, credit-defense trades normally increase.

Q2. Which of the following is the best rationale for purchasing an issue in the secondary market?

A)   Expectations of an upgrade in an issuer's credit quality.

B)   High-default rates in a particular sector.

C)   Increasing credit risk for a particular bond.

Correct answer is A)

An upgrade in credit quality will result in less credit-premium demanded by investors. Since discount rates and prices move in opposite directions for bonds, credit upgrades will result in an increase in price that will generate a greater total return from the investment.

Q3. Estimates are that more than 50% of all secondary bond trading is due to which type of trade?

A)   Yield/spread pickup.

B)   Curve adjustment.

C)   New issue swaps.

Correct answer is A)

The motivation behind yield/spread pickup trades is to increase yield within specified duration and credit quality bounds. This motivation is estimated to account for more than 50% of all secondary trades.

Q4. Expectations that an issue will experience a quality upgrade that is not already reflected in the current spread could result in which type of trade?

A)   Sector rotation.

B)   Credit defense.

C)   Credit-upside.

Correct answer is C)

A credit-upside trade is motivated by a bond portfolio manager’s expectation that an issuer will experience a credit upgrade, and belief that this is not already reflected in the market value of the issue.

Q5. On-the-run Treasuries are frequently perceived to have superior liquidity. Based on this rational, many bond managers engage in:

A)   curve adjustment trades.

B)   new issue swaps.

C)   credit defense trades.

Correct answer is B)

Relatively large new issues, particularly Treasuries that have just been issued (on-the-run), are believed to have superior liquidity—a rationale for including more of them in the portfolio.

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