LOS a: Evaluate, using relative value analysis, whether a security is undervalued or overvalued.

Q1. The following are the yields on various bonds. The relevant benchmark is that of Treasury securities.

Is the ABC bond undervalued or overvalued and why? Using relative value analysis, the ABC bond is:

A)   undervalued because its yield is greater than that of Treasuries.

B)   undervalued because its spread is greater than that of comparable bonds.

C)   overvalued because its spread is greater than that of comparable bonds.

Q2. The following are the yields on various bonds. The relevant benchmark is that of the bond sector.

Is the ABC bond undervalued or overvalued and why? Using relative value analysis, the ABC bond is:

A)   undervalued because its yield is less than that of Treasuries.

B)   undervalued because its spread is less than that of comparable bonds.

C)   overvalued because its spread is less than that of comparable bonds.

Q3. The purpose of relative value analysis is to determine:

A)   the return differential from riding the yield curve.

B)   whether a bond is fairly valued using a benchmark yield.

C)   whether a stock is fairly valued using present value calculations.

LOS a: Evaluate, using relative value analysis, whether a security is undervalued or overvalued. fficeffice" />

Q1. The following are the yields on various bonds. The relevant benchmark is that of Treasury securities.

Treasury Bond Yield	4.00%
Bond Sector Yield	4.50%
Comparable Bond Yield	6.00%
ABC Bond Yield	6.50%

Is the ABC bond undervalued or overvalued and why? Using relative value analysis, the ABC bond is:

A)   undervalued because its yield is greater than that of Treasuries.

B)   undervalued because its spread is greater than that of comparable bonds.

C)   overvalued because its spread is greater than that of comparable bonds.

Correct answer is B)

The purpose of relative value analysis is to determine whether a bond is fairly valued. The bond’s spread over some benchmark is compared to that of a required spread to determine whether the bond is fairly valued. The required spread will be that available on comparable securities. In this example, the relevant benchmark was Treasury securities. The spread for ABC bonds over Treasuries was 2.5%. The spread for comparable bonds over Treasuries was 2.0%. The higher spread for ABC bonds means that they are relatively undervalued (their price is low because their yield is higher).

Q2. The following are the yields on various bonds. The relevant benchmark is that of the bond sector.

Treasury Bond Yield	3.00%
Bond Sector Yield	3.25%
Comparable Bond Yield	5.75%
ABC Bond Yield	5.50%

Is the ABC bond undervalued or overvalued and why? Using relative value analysis, the ABC bond is:

A)   undervalued because its yield is less than that of Treasuries.

B)   undervalued because its spread is less than that of comparable bonds.

C)   overvalued because its spread is less than that of comparable bonds.

Correct answer is C)

The purpose of relative value analysis is to determine whether a bond is fairly valued. The bond’s spread over some benchmark is compared to that of a required spread to determine whether the bond is fairly valued. The required spread will be that available on comparable securities. In this example, the relevant benchmark was the bond sector. The spread for ABC bonds over the bond sector was 2.25%. The spread for comparable bonds over the bond sector was 2.50%. The lower spread for ABC bonds means that they are relatively overvalued (their price is high because their yield is lower).

Q3. The purpose of relative value analysis is to determine:

A)   the return differential from riding the yield curve.

B)   whether a bond is fairly valued using a benchmark yield.

C)   whether a stock is fairly valued using present value calculations.

Correct answer is B)

The purpose of relative value analysis is to determine whether a bond is fairly valued. The bond’s spread over some benchmark is compared to that of a required spread to determine whether the bond is fairly valued. The required spread will be that available on comparable securities.

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