optiix

One portfolio constraint contributing to market inefficiency in global credit markets is seasonality. Considering the trading patterns of a given mutual fund, which of the following is least likely to reflect seasonality?

A) Relatively low secondary trading at the end of a month.

B) Relatively low secondary trading following a portfolio rebalancing.

C) Relatively high secondary trading following a new primary issue.

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

optiix

Which of the following market conditions would suggest the use of callable bond structures in a corporate bond portfolio?

A) Bull bond market.

B) Bear bond market.

C) Increasing interest rate volatility and a bull bond market.

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

optiix

Which of the following statements about spread analysis is CORRECT?

A) With quality-spread analysis, one risk when purchasing a security is the spread differential narrowing during the holding period.

B) Percentage yield analysis uses the ratio between corporate bond yields and government yields and is the only spread analysis that is based on maturity rather than duration.

C) Using quality-spread analysis, a bond portfolio manager would buy an issue that has a wider spread than what is justified by its intrinsic value.

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

optiix

Which of the following statements about swaps is CORRECT?

A) A swap spread is the spread paid by the fixed-rate payer over the seasoned Treasury rate.

B) In the European market, swap spreads serve as a good proxy for credit spreads.

C) A swap spread refers to the difference in yield between corporate issues of different quality ratings.

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

optiix

Which of the following is a potential criticism of a strategy that invests in securities that are "neglected" by the market? This type of security:

A) often has low liquidity.

B) has a lower risk-return tradeoff.

C) is often overpriced.

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

optiix

In terms of a long-term investor, which of the following is a potential criticism of not investing in securities with low liquidity? These securities:

A) offer arbitrage opportunities more frequently.

B) are less risky.

C) have to provide higher returns as a compensation for low liquidity.

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

optiix

Which of the following strategies would normally result in the best bond performance?

A) Buy callable bonds rather than bullets, if a strong bullish bond market is expected.

B) If a bear bond market is expected, buy callable bonds instead of bullets.

C) Buy callable bonds when interest rates decline.

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Callable bonds generally outperform bullets in a bear bond market because the probability of a call is reduced. As interest rates increase, the value of the embedded option decreases, with a resultant decrease in the differential yield between callable and noncallable bonds. In a bull bond market the call option acts as a resistance point limiting the price appreciation of callable bonds.

optiix

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.

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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.

optiix

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.

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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.

optiix

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

A) Curve adjustment.

B) Yield/spread pickup.

C) New issue swaps.

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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.