Question on fixed income income

brk1yn

Here is a question that I have NO idea which would be right. These are the type of conceptual questions that give me problems, and it worries me that I am completely guessing on these..would anyone here know the right answer or how to deduce it and enlighten me?

- Which of the fllowing statements about the risks associated with investing in bonds is MOST accurate ?

A. Corporate debentures are not subject to prepayment risk
B. Liquidity risk is not relevant if the portfolio manager intends to hold the bond to maturity
C.Event risk refers tot he possibility that the issuer breaches one of its debt covenants and triggers a "credit event"

Am I screwed not knowing this? These frustrate me so...

ishfaque

B looks valid.
A. Debentures are simply not secured debt, why no prepayment risk if debenture for example has sinking fund, or call option.
C. That's not event, that is credit risk

soddy1979

A is valid. Only amortizing securities are subject to prepayment risk.

C is the wrong definition.

B is wrong because liquidity risk is still relevant if the manager needs to mark holdings to market for performance reporting purposes. Low liquidity for bond can mean prevailing price is not accurate measure of bond's value. Also, an illiquid market for an instrument like this is undesirable. I wanna be able to sell when I want goddamit!

I know this is right because I have done this question before.



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 04:59PM by robjames1984.

ogoluwa

Maybe commercial paper would qualify as a corporate debenture.

agulani

JRossSter Wrote:
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> What exactly is a corporate debenture so I can
> visualize and attack?

Simply a corporate bond which is not secured by any assets.

joemoran

Corporate debenture is unsecured debt...not of high quality!!

thisisbrianly

Hmm...why wouldn't a debenture be subject to prepayment risk? Doesn't debenture just mean that its unsecured?

dece2011

thanks guys... is there a good way of knowing what debt would be amortized? obviously MBS but anything else?

cchang

thisisbrianly Wrote:
-------------------------------------------------------
> Hmm...why wouldn't a debenture be subject to
> prepayment risk? Doesn't debenture just mean that
> its unsecured?


thisisbrianly, that was my initial way of thinking to but CFA curriculum separates call risk (call option) from prepayment risk and prepayment refers only to mortgage backed securities and asset back securities. Since debenture is not one of these (as it is only secured by full faith ;) of issuer and not by any asset, it can't be prepaid.

It could be called when it has call option but they call it call risk specifically. And now a quick quiz - how many "calls" in previous sentence ? ;)



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 05:40PM by dadalsky.

kmf229

amoritizing debt is any debt instrument that the payment is made up of interest and principal and typically give the borrower the option to pay early. So think about it... that includes mortgages, MBS, CMOs (also things like car-payments). Corporate debt typically pays interest, then principal at the end, therefore no prepayment risk.