CFAI 6 - Equity & Fixed Income

Question 1

The main functions of the financial system are to facilitate:

Answer 1

1 the achievement of the purposes for which people use the financial system;

• to save money for the future;
• to borrow money for current use;
• to raise equity capital;
• to manage risks;
• to exchange assets for immediate and future deliveries; and
• to trade on information.

2 The discovery of the rates of return that equate
aggregate savings with aggregate borrowings;

3 The allocation of capital to the best uses.

Question 2

CFD meaning and how can it be settled?

Cash settled or physical settled?

Answer 2

Contract for difference, can only be cash settled. Is an agreement with one entity to pay the difference in the value.

Question 3

Forward contract

Answer 3

A forward contract is an agreement to trade the underlying asset in the future at a price agreed upon today. For example, a contract for the sale of wheat after the harvest is a forward contract. People often use forward contracts to reduce risk. Before planting wheat, farmers like to know the price at which they will sell their crop. Similarly, before committing to sell flour to bakers in the future, millers like to know the prices that they will pay for wheat. The farmer and the miller both reduce their operating risks by agreeing to trade wheat forward.

Same as the future but can be customized since it is done in OTC (over the counter)

Question 4

brooker-dealers have a conflit of interest while acting, why?

Answer 4

because they need to act in regard of their clients as a brooker and get the better price in the market to sell their assets/buy. As a dealer they want to buy cheaper and sell at higher prices so if they buy the assets to their clients they are probably not getting the best price.

Question 5

primary dealers?

Answer 5

They are dealers with which the central banks trade when they do monetary policy.

Question 6

3 main risks for insurance companies

Answer 6

fraud, moral hazard, and adverse selection—that often plague insurance markets. Fraud occurs when people deliberately cause or falsely report losses to collect on insurance. Moral hazard occurs when people are less careful about avoiding insured losses than they would be if they were not insured so that losses occur more often than they would otherwise. Adverse selection occurs when only those who are most at risk buy insurance so that insured losses tend to be greater than average.

Question 7

How can be leverage ratio calculated and what is banco Best max leverage ratio?

Answer 7

3 is the max.

The leverage ratio equals the number of $ that you have on your portfolio for each $ that is owned by urself.

Question 8

In what ways do private placements differ from public placements?

Answer 8

Issuers make private placements to a limited number of investors that generally are financially sophisticated and well informed about risk. The investors generally have some relationship to the issuer. Issuers make public placements when they sell securities to the general public. Public placements generally require substantially more financial disclosure than do private placements.

Question 9

• What is the main advantage of a call market compared with a continuous trading market?
• What is the main advantage of a continuous trading market compared with a call market?

Answer 9

Solution to 1:

By gathering all traders to the same place at the same time, a call market makes it easier for buyers to find sellers and vice versa. In contrast, if buyers and sellers (or their orders) are not present at the same time in a continuous market, they cannot trade.

Solution to 2:

In a continuous trading market, a willing buyer and seller can trade at anytime the market is open. In contrast, in a call market trading can take place only when the market is called.

Question 10

What are the primary advantages of quote-driven, order-driven, and brokered markets?

Answer 10

In a quote-driven market, dealers generally are available to supply liquidity. In an order-driven market, traders can supply liquidity to each other. In a brokered market, brokers help find traders who are willing to trade when dealers would not be willing to make markets and when traders would not be willing to post orders.

Question 11

Akihiko Takabe has designed a sophisticated forecasting model, which predicts the movements in the overall stock market, in the hope of earning a return in excess of a fair return for the risk involved. He uses the predictions of the model to decide whether to buy, hold, or sell the shares of an index fund that aims to replicate the movements of the stock market. Takabe would best be characterized as a(n):
A.hedger.
B.investor.
C.information-motivated trader.

Answer 11

C is correct. Takabe is best characterized as an information-motivated trader. Takabe believes that his model provides him superior information about the movements in the stock market and his motive for trading is to profit from this information.

Question 12

An investor primarily invests in stocks of publicly traded companies. The investor wants to increase the diversification of his portfolio. A friend has recommended investing in real estate properties. The purchase of real estate would best be characterized as a transaction in the:
A.derivative investment market.
B.traditional investment market.
C.alternative investment market.

Answer 12

C is correct. The purchase of real estate properties is a transaction in the alternative investment market.

Question 13

A friend has asked you to explain the differences between open-end and closed-end funds. Which of the following will you most likely include in your explanation?
A.Closed-end funds are unavailable to new investors.
B.When investors sell the shares of an open-end fund, they can receive a discount or a premium to the fund’s net asset value.
C.When selling shares, investors in an open-end fund sell the shares back to the fund whereas investors in a closed-end fund sell the shares to others in the secondary market.

Answer 13

C is correct. When investors want to sell their shares, investors of an open-end fund sell the shares back to the fund whereas investors of a closed-end fund sell the shares to others in the secondary market. Closed-end funds are available to new investors but they must purchase shares in the fund in the secondary market. The shares of a closed-end fund trade at a premium or discount to net asset value.

Question 14

The usefulness of a forward contract is limited by some problems. Which of the following is most likely one of those problems?
A.Once you have entered into a forward contract, it is difficult to exit from the contract.
B.Entering into a forward contract requires the long party to deposit an initial amount with the short party.
C.If the price of the underlying asset moves adversely from the perspective of the long party, periodic payments must be made to the short party.

Answer 14

A is correct. Once you have entered into a forward contract, it is difficult to exit from the contract. As opposed to a futures contract, trading out of a forward contract is quite difficult. There is no exchange of cash at the origination of a forward contract. There is no exchange on a forward contract until the maturity of the contract.

Question 15

A German company that exports machinery is expecting to receive $10 million in three months. The firm converts all its foreign currency receipts into euros. The chief financial officer of the company wishes to lock in a minimum fixed rate for converting the $10 million to euro but also wants to keep the flexibility to use the future spot rate if it is favorable. What hedging transaction is most likely to achieve this objective?
A.Selling dollars forward.
B.Buying put options on the dollar.
C.Selling futures contracts on dollars.

Answer 15

B is correct. Buying a put option on the dollar will ensure a minimum exchange rate but does not have to be exercised if the exchange rate moves in a favorable direction. Forward and futures contracts would lock in a fixed rate but would not allow for the possibility to profit in case the value of the dollar three months later in the spot market turns out to be greater than the value in the forward or futures contract.

Question 16

A book publisher requires substantial quantities of paper. The publisher and a paper producer have entered into an agreement for the publisher to buy and the producer to supply a given quantity of paper four months later at a price agreed upon today. This agreement is a:
A.futures contract.
B.forward contract.
C.commodity swap.

Answer 16

B is correct. The agreement between the publisher and the paper supplier to respectively buy and supply paper in the future at a price agreed upon today is a forward contract.

Question 17

Jason Schmidt works for a hedge fund and he specializes in finding profit opportunities that are the result of inefficiencies in the market for convertible bonds—bonds that can be converted into a predetermined amount of a company’s common stock. Schmidt tries to find convertibles that are priced inefficiently relative to the underlying stock. The trading strategy involves the simultaneous purchase of the convertible bond and the short sale of the underlying common stock. The above process could best be described as:
A.hedging.
B.arbitrage.
C.securitization.

Answer 17

B is correct. The process can best be described as arbitrage because it involves buying and selling instruments, whose values are closely related, at different prices in different markets.

Question 18

Pierre-Louis Robert just purchased a call option on shares of the Michelin Group. A few days ago he wrote a put option on Michelin shares. The call and put options have the same exercise price, expiration date, and number of shares underlying. Considering both positions, Robert’s exposure to the risk of the stock of the Michelin Group is:
A.long.
B.short.
C.neutral.

Answer 18

A is correct. Robert’s exposure to the risk of the stock of the Michelin Group is long. The exposure as a result of the long call position is long. The exposure as a result of the short put position is also long. Therefore, the combined exposure is long.

Question 19

An online brokerage firm has set the minimum margin requirement at 55 percent. What is the maximum leverage ratio associated with a position financed by this minimum margin requirement?
A.1.55.
B.1.82.
C.2.22.

Answer 19

B is correct. The maximum leverage ratio is 1.82 = 100% position ÷ 55% equity. The maximum leverage ratio associated with a position financed by the minimum margin requirement is one divided by the minimum margin requirement.

Question 20

A trader has purchased 200 shares of a non-dividend-paying firm on margin at a price of $50 per share. The leverage ratio is 2.5. Six months later, the trader sells these shares at $60 per share. Ignoring the interest paid on the borrowed amount and the transaction costs, what was the return to the trader during the six-month period?
A.20 percent.
B.33.33 percent.
C.50 percent.

Answer 20

C is correct. The return is 50 percent. If the position had been unleveraged, the return would be 20% = (60 – 50)/50. Because of leverage, the return is 50% = 2.5 × 20%.
Another way to look at this problem is that the equity contributed by the trader (the minimum margin requirement) is 40% = 100% ÷ 2.5. The trader contributed $20 = 40% of $50 per share. The gain is $10 per share, resulting in a return of 50% = 10/20.

Question 21

Jason Williams purchased 500 shares of a company at $32 per share. The stock was bought on 75 percent margin. One month later, Williams had to pay interest on the amount borrowed at a rate of 2 percent per month. At that time, Williams received a dividend of $0.50 per share. Immediately after that he sold the shares at $28 per share. He paid commissions of $10 on the purchase and $10 on the sale of the stock. What was the rate of return on this investment for the one-month period?
A.−12.5 percent.
B.–15.4 percent.
C.–50.1 percent.

Answer 21

B is correct. The return is –15.4 percent.
Total cost of the purchase = $16,000 = 500 × $32
Equity invested = $12,000 = 0.75 × $16,000
Amount borrowed = $4,000 = 16,000 – 12,000
Interest paid at month end = $80 = 0.02 × $4,000
Dividend received at month end = $250 = 500 × $0.50
Proceeds on stock sale = $14,000 = 500 × $28
Total commissions paid = $20 = $10 + $10
Net gain/loss = −$1,850 = −16,000 − 80 + 250 + 14,000 − 20
Initial investment including commission on purchase = $12,010
Return = −15.4% = −$1,850/$12,010

Question 22

The current price of a stock is $25 per share. You have $10,000 to invest. You borrow an additional $10,000 from your broker and invest $20,000 in the stock. If the maintenance margin is 30 percent, at what price will a margin call first occur?
A.$9.62.
B.$17.86.
C.$19.71.

Answer 22

B is correct. A margin call will first occur at a price of $17.86. Because you have contributed half and borrowed the remaining half, your initial equity is 50 percent of the initial stock price, or $12.50 = 0.50 × $25. If P is the subsequent price, your equity would change by an amount equal to the change in price. So, your equity at price P would be 12.50 + (P – 25). A margin call will occur when the percentage margin drops to 30 percent. So, the price at which a margin call will occur is the solution to the following equation.

Equity/SharePrice/Share=12.50+P−25P=30%

The solution is P = $17.86.

Question 23

A market has the following limit orders standing on its book for a particular stock. The bid and ask sizes are number of shares in hundreds.

Bid Size

                                   Limit Price (€)

                                                                      Offer Size 5                                            9.73  12                                           9.81  4                                            9.84  6                                            9.95 
                                         10.02                        5
                                         10.10                         12
                                          10.14                         8

What is the market?
A.9.73 bid, offered at 10.14.
B.9.81 bid, offered at 10.10.
C.9.95 bid, offered at 10.02.

Answer 23

C is correct. The market is 9.95 bid, offered at 10.02. The best bid is at €9.95 and the best offer is €10.02.

Question 24

Consider the following limit order book for a stock. The bid and ask sizes are number of shares in hundreds.

Bid Size

                                 Limit Price (¥)

                                                                    Offer Size 3                                      122.80 8                                      123.00  4                                      123.35 
                                     123.80                       7
                                     124.10                        6 
                                     124.50                         7

A new buy limit order is placed for 300 shares at ¥123.40. This limit order is said to:
A.take the market.
B.make the market.
C.make a new market.

Answer 24

C is correct. This order is said to make a new market. The new buy order is at ¥123.40, which is better than the current best bid of ¥123.35. Therefore, the buy order is making a new market. Had the new order been at ¥123.35, it would be said to make the market. Because the new buy limit order is at a price less than the best offer of ¥123.80, it will not immediately execute and is not taking the market.

Question 25

Jim White has sold short 100 shares of Super Stores at a price of $42 per share. He has also simultaneously placed a “good-till-cancelled, stop 50, limit 55 buy” order. Assume that if the stop condition specified by White is satisfied and the order becomes valid, it will get executed. Excluding transaction costs, what is the maximum possible loss that White can have?
A.$800.
B.$1,300.
C.Unlimited.

Answer 25

B is correct. The maximum possible loss is $1,300. If the stock price crosses $50, the stop buy order will become valid and will get executed at a maximum limit price of $55. The maximum loss per share is $13 = $55 – $42, or $1,300 for 100 shares.

Question 26

You own shares of a company that are currently trading at $30 a share. Your technical analysis of the shares indicates a support level of $27.50. That is, if the price of the shares is going down, it is more likely to stay above this level rather than fall below it. If the price does fall below this level, however, you believe that the price may continue to decline. You have no immediate intent to sell the shares but are concerned about the possibility of a huge loss if the share price declines below the support level. Which of the following types of orders could you place to most appropriately address your concern?
A.Short sell order.
B.Good-till-cancelled stop sell order.
C.Good-till-cancelled stop buy order.

Answer 26

B is correct. The most appropriate order is a good-till-cancelled stop sell order. This order will be acted on if the stock price declines below a specified price (in this case, $27.50). This order is sometimes referred to as a good-till-cancelled stop loss sell order. You are generally bullish about the stock, as indicated by no immediate intent to sell, and would expect a loss on short selling the stock. A stop buy order is placed to buy a stock when the stock is going up.

Question 27

A security market index represents the:
A.risk of a security market.
B.security market as a whole.
C.security market, market segment, or asset class.

Answer 27

C is correct. A security market index represents the value of a given security market, market segment, or asset class.

Question 28

The values of a price return index and a total return index consisting of identical equal-weighted dividend-paying equities will be equal:
A.only at inception.
B.at inception and on rebalancing dates.
C.at inception and on reconstitution dates.

Answer 28

A is correct. At inception, the values of the price return and total return versions of an index are equal.

Question 29

Which of the following index weighting methods requires an adjustment to the divisor after a stock split?
A.Price weighting.
B.Fundamental weighting.
C.Market-capitalization weighting.

Answer 29

A is correct. In the price weighting method, the divisor must be adjusted so the index value immediately after the split is the same as the index value immediately prior to the split.

Question 30

A float-adjusted market-capitalization-weighted index weights each of its constituent securities by its price and:
A.its trading volume.
B.the number of its shares outstanding.
C.the number of its shares available to the investing public.

Answer 30

C is correct. “Float” is the number of shares available for public trading.

Question 31

Which of the following index weighting methods is most likely subject to a value tilt?
A.Equal weighting.
B.Fundamental weighting.
C.Market-capitalization weighting.

Answer 31

B is correct. Fundamental weighting leads to indices that have a value tilt.

Question 32

Reconstitution of a security market index reduces:
A.portfolio turnover.
B.the need for rebalancing.
C.the likelihood that the index includes securities that are not representative of the target market.

Answer 32

C is correct. Reconstitution is the process by which index providers review the constituent securities, re-apply the initial criteria for inclusion in the index, and select which securities to retain, remove, or add. Constituent securities that no longer meet the criteria are replaced with securities that do. Thus, reconstitution reduces the likelihood that the index includes securities that are not representative of the target market.

Question 33

Security market indices are used as:
A.measures of investment returns.
B.proxies to measure unsystematic risk.
C.proxies for specific asset classes in asset allocation models.

Answer 33

C is correct. Security market indices play a critical role as proxies for asset classes in asset allocation models.

Question 34

Which of the following is an example of a style index? An index based on:
A.geography.
B.economic sector.
C.market capitalization.

Answer 34

C is correct. Style indices represent groups of securities classified according to market capitalization, value, growth, or a combination of these characteristics.

Question 35

An aggregate fixed-income index:
A.comprises corporate and asset-backed securities.
B.represents the market of government-issued securities.
C.can be subdivided by market or economic sector to create more narrowly defined indices.

Answer 35

C is correct. An aggregate fixed-income index can be subdivided by market sector (government, government agency, collateralized, corporate), style (maturity, credit quality), economic sector, or some other characteristic to create more narrowly defined indices.

Question 36

Fixed-income indices are least likely constructed on the basis of:
A.maturity.
B.type of issuer.
C.coupon frequency.

Answer 36

C is correct. Coupon frequency is not a dimension on which fixed-income indices are based.

Question 37

Which of the following statements is most accurate?
A.Commodity indices all share similar weighting methods.
B.Commodity indices containing the same underlying commodities offer similar returns.
C.The performance of commodity indices can be quite different from that of the underlying commodities.

Answer 37

C is correct. The performance of commodity indices can be quite different from that of the underlying commodities because the indices consist of futures contracts on the commodities rather than the actual commodities.

Question 38

Which of the following is not a real estate index category?
A.Appraisal index.
B.Initial sales index.
C.Repeat sales index.

Answer 38

B is correct. It is not a real estate index category.

Question 39

A unique feature of hedge fund indices is that they:
A.are frequently equal weighted.
B.are determined by the constituents of the index.
C.reflect the value of private rather than public investments.

Answer 39

B is correct. Hedge funds are not required to report their performance to any party other than their investors. Therefore, each hedge fund decides to which database(s) it will report its performance. Thus, for a hedge fund index, constituents determine the index rather than index providers determining the constituents.

Question 40

The returns of hedge fund indices are most likely:
A.biased upward.
B.biased downward.
C.similar across different index providers.

Answer 40

A is correct. Voluntary performance reporting may lead to survivorship bias, and poorer performing hedge funds will be less likely to report their performance.

Question 41

The costs incurred by traders in identifying and exploiting possible market inefficiencies affect the interpretation of market efficiency.

Answer 41

The two types of costs to consider are transaction costs and information-acquisition costs.

In summary, a modern perspective calls for the investor to consider transaction costs and information-acquisition costs when evaluating the efficiency of a market. A price discrepancy must be sufficiently large to leave the investor with a profit (adjusted for risk) after taking account of the transaction costs and information-acquisition costs to reach the conclusion that the discrepancy may represent a market inefficiency. Prices may somewhat less than fully reflect available information without there being a true market opportunity for active investors.

Question 42

Os mercados eficientes na forma fraca estão sempre presentes em todos os mercados? (por estudos empíricos)

Answer 42

Há países, maioritariamente subdesenvolvidos em que a teoria semi forte não se encontra e por vezes nem a forma fraca de mercados eficientes, o que permite obter retornos anormais com análise técnica visto que os preços passados não estão reflectidos no preço atual.

Question 43

É possível obter retornos anormais após sairem dados de uma empresa muito acima do esperado?

Answer 43

Os ajustamentos de preço são feitos lentamente, daí que podemos obter retornos anormais a comprar empresas com resultados apresentados muito acima do esperado e vender empresas com resultados apresentados muito abaixo do esperado.

Question 44

The intrinsic value of an undervalued asset is:
A.less than the asset’s market value.
B.greater than the asset’s market value.
C.the value at which the asset can currently be bought or sold.

Answer 44

B is correct. The intrinsic value of an undervalued asset is greater than the market value of the asset, where the market value is the transaction price at which an asset can be currently bought or sold.

Question 45

With respect to the efficient market hypothesis, if security prices reflect only past prices and trading volume information, then the market is:
A.weak-form efficient.
B.strong-form efficient.
C.semi-strong-form efficient.

Answer 45

•A is correct. The weak-form efficient market hypothesis is defined as a market where security prices fully reflect all market data, which refers to all past price and trading volume information.

Question 46

Which one of the following statements best describes the semi-strong form of market efficiency?
A.Empirical tests examine the historical patterns in security prices.
B.Security prices reflect all publicly known and available information.
C.Semi-strong-form efficient markets are not necessarily weak-form efficient.

Answer 46

•B is correct. In semi-strong-form efficient markets, security prices reflect all publicly available information.

Question 47

Technical analysts assume that markets are:
A.weak-form efficient.
B.weak-form inefficient.
C.semi-strong-form efficient.

Answer 47

•B is correct. Technical analysts use past prices and volume to predict future prices, which is inconsistent with the weakest form of market efficiency (i.e., weak-form market efficiency). Weak-form market efficiency states that investors cannot earn abnormal returns by trading on the basis of past trends in price and volume.

Question 48

Fundamental analysts assume that markets are:
A.weak-form inefficient.
B.semi-strong-form efficient.
C.semi-strong-form inefficient.

Answer 48

•C is correct. Fundamental analysts use publicly available information to estimate a security’s intrinsic value to determine if the security is mispriced, which is inconsistent with the semi-strong form of market efficiency. Semi-strong-form market efficiency states that investors cannot earn abnormal returns by trading based on publicly available information.

Question 49

An increase in the time between when an order to trade a security is placed and when the order is executed most likely indicates that market efficiency has:
A.decreased.
B.remained the same.
C.increased.

Answer 49

A is correct. Operating inefficiencies reduce market efficiency.

Question 50

With respect to efficient markets, a company whose share price reacts gradually to the public release of its annual report most likely indicates that the market where the company trades is:
A.semi-strong-form efficient.
B.subject to behavioral biases.
C.receiving additional information about the company.

Answer 50

C is correct. If markets are efficient, the information from the annual report is reflected in the stock prices; therefore, the gradual changes must be from the release of additional information.

Question 51

Which of the following is least likely to explain the January effect anomaly?
A.Tax-loss selling.
B.Release of new information in January.
C.Window dressing of portfolio holdings.

Answer 51

B is correct. The excess returns in January are not attributed to any new information or news; however, research has found that part of the seasonal pattern can be explained by tax-loss selling and portfolio window dressing.

Question 52

If a researcher conducting empirical tests of a trading strategy using time series of returns finds statistically significant abnormal returns, then the researcher has most likely found:
A.a market anomaly.
B.evidence of market inefficiency.
C.a strategy to produce future abnormal returns.

Answer 52

A is correct. Finding significant abnormal returns does not necessarily indicate that markets are inefficient or that abnormal returns can be realized by applying the strategy to future time periods. Abnormal returns are considered market anomalies because they may be the result of the model used to estimate the expected returns or may be the result of underestimating transaction costs or other expenses associated with implementing the strategy, rather than because of market inefficiency.

Question 53

•Observed overreactions in markets can be explained by an investor’s degree of:
A.risk aversion.
B.loss aversion.
C.confidence in the market.

Answer 53

•B is correct. Behavioral theories of loss aversion can explain observed overreaction in markets, such that investors dislike losses more than comparable gains (i.e., risk is not symmetrical).

Question 54

•Like traditional finance models, the behavioral theory of loss aversion assumes that investors dislike risk; however, the dislike of risk in behavioral theory is assumed to be:
A.leptokurtic.
B.symmetrical.
C.asymmetrical.

Answer 54

•C is correct. Behavioral theories of loss aversion allow for the possibility that the dislike for risk is not symmetrical, which allows for loss aversion to explain observed overreaction in markets such that investors dislike losses more than they like comparable gains.

Question 55

Tipos de votação :

Statutory voting

Cumulative Voting.. como são?

Answer 55

Statutory voting 1 share 1 vote

Cumulative voting - Permite uma maior representação de pequenos accionistas, se estes aplicarem os seus votodos todos no mesmo candidato. Dão um voto por cada “board director being elected” se forem 2 temos 2 votos por cada ação podendo assim aplicar todos no mesmo.

Question 56

callable e putable stocks

Answer 56

callable podem ser recomprados pela empresa a um determinado preço. ( aumenta risco para o investidor)

putable, podem ser vendidas à empresa a um determinado preço (reduz risco para o investido)

Question 57

Convertible (in common shares) Preference Shares Advantages

Answer 57

• They allow investors to earn a higher dividend than if they invested in the company’s common shares.
• They allow investors the opportunity to share in the profits of the company.
• They allow investors to benefit from a rise in the price of the common shares through the conversion option.
• Their price is less volatile than the underlying common shares because the dividend payments are known and more stable.

Question 58

3 tipos de private equity investments e vantagens.

Answer 58

Venture Capital - investimento em negócios embrionários. Capital de risco.

Leveraged Buyout - occurs when a group of investors (such as the company’s management or a private equity partnership) uses a large amount of debt to purchase all of the outstanding common shares of a publicly traded company. In cases where the group of investors acquiring the company is primarily comprised of the company’s existing management, the transaction is referred to as a management buyout (MBO). After the shares are purchased, they cease to trade on an exchange and the investor group takes full control of the company.

Private investment in public equity - This type of investment is generally sought by a public company that is in need of additional capital quickly and is willing to sell a sizeable ownership position to a private investor or investor group. For example, a company may require a large investment of new equity funds in a short period of time because it has significant expansion opportunities, is facing high levels of indebtedness, or is experiencing a rapid deterioration in its operations. Depending on how urgent the need is and the size of the capital requirement, the private investor may be able to purchase shares in the company at a significant discount to the publicly-quoted market price.

O objetivo do investimento privado é melhorar a empresa para a tornar lucrativa numa ótica de longo prazo e posteriormente voltar a turnar a empresa publica, lucrando no processo.

Question 59

Market value of equity

Book value of equity

Price to book

Answer 59

Market Value of Equity - Shares * price

Book Value of Equity - Equity/ Shares

Price to book - Price / (Book Value of Equity)

Question 60

The type of equity voting right that grants one vote for each share of equity owned is referred to as:
A.proxy voting.
B.statutory voting.
C.cumulative voting

Answer 60

B is correct. Statutory voting is the type of equity voting right that grants one vote per share owned.

Question 61

•Participating preference shares entitle shareholders to:
A.participate in the decision-making process of the company.
B.convert their shares into a specified number of common shares.
C.receive an additional dividend if the company’s profits exceed a pre-determined level.

Answer 61

•C is correct. Participating preference shares entitle shareholders to receive an additional dividend if the company’s profits exceed a pre-determined level.

Question 62

•Which of the following statements about private equity securities is incorrect?
A.They cannot be sold on secondary markets.
B.They have market-determined quoted prices.
C.They are primarily issued to institutional investors.

Answer 62

•B is correct. Private equity securities do not have market-determined quoted prices.

Question 63

•Emerging markets have benefited from recent trends in international markets. Which of the following has not been a benefit of these trends?
A.Emerging market companies do not have to worry about a lack of liquidity in their home equity markets.
B.Emerging market companies have found it easier to raise capital in the markets of developed countries.
C.Emerging market companies have benefited from the stability of foreign exchange markets.

Answer 63

•C is correct. The trends in emerging markets have not led to the stability of foreign exchange markets.

Question 64

•When investing in unsponsored depository receipts, the voting rights to the shares in the trust belong to:
A.the depository bank.
B.the investors in the depository receipts.
C.the issuer of the shares held in the trust.

Answer 64

•A is correct. In an unsponsored DR, the depository bank owns the voting rights to the shares. The bank purchases the shares, places them into a trust, and then sells shares in the trust—not the underlying shares—in other markets.

Question 65

•With respect to Level III sponsored ADRs, which of the following is least likely to be accurate? They:
A.have low listing fees.
B.are traded on the NYSE, NASDAQ, and AMEX.
C.are used to raise equity capital in US markets.

Answer 65

•A is correct. The listing fees on Level III sponsored ADRs are high.

Question 66

Which of the following is not a primary goal of raising equity capital?
A.To finance the purchase of long-lived assets.
B.To finance the company’s revenue-generating activities.
C.To ensure that the company continues as a going concern.

Answer 66

C is correct. Capital is raised to ensure the company’s existence only when it is required. It is not a typical goal of raising capital.

Question 67

Holding all other factors constant, which of the following situations will most likely lead to an increase in a company’s return on equity?
A.The market price of the company’s shares increases.
B.Net income increases at a slower rate than shareholders’ equity.
C.The company issues debt to repurchase outstanding shares of equity

Answer 67

C is correct. A company’s ROE will increase if it issues debt to repurchase outstanding shares of equity.

Question 68

A company’s cost of equity is often used as a proxy for investors’:
A.average required rate of return.
B.minimum required rate of return.
C.maximum required rate of return.

Answer 68

B is correct. Companies try to raise funds at the lowest possible cost. Therefore, cost of equity is used as a proxy for the minimum required rate of return.

Question 69

•The GICS classification system classifies companies on the basis of a company’s primary business activity as measured primarily by:
A.assets.
B.income.
C.revenue.

•Which of the following is least likely to be accurately described as a cyclical company? A(n):
A.automobile manufacturer.
B.producer of breakfast cereals.
C.apparel company producing the newest trendy clothes for teenage girls.

•Which of the following is the most accurate statement? A statistical approach to grouping companies into industries:
A.is based on historical correlations of the securities’ returns.
B.frequently produces industry groups whose composition is similar worldwide.
C.emphasizes the descriptive statistics of industries consisting of companies producing similar products and/or services.

Answer 69

Solution to 1:
C is correct.

Solution to 2:
B is correct. A producer of staple foods such as cereals is a classic example of a non-cyclical company. Demand for automobiles is cyclical—that is, relatively high during economic expansions and relatively low during economic contractions. Also, demand for teenage fashions is likely to be more sensitive to the business cycle than demand for standard food items such as breakfast cereals. When budgets have been reduced, families may try to avoid expensive clothing or extend the life of existing wardrobes.

Solution to 3:
A is correct.

Question 70

The three main approaches to classifying companies are:

Answer 70

• products and/or services supplied;
• business-cycle sensitivities; and
• statistical similarities.

Question 71

External influences on industry growth, profitability, and risk include:

Answer 71

• technology;
• demographics;
• government; and
• social factors.

Question 72

Which of the following is least likely to involve industry analysis?
A.Sector rotation strategy.
B.Top-down fundamental investing.
C.Tactical asset allocation strategy.

Answer 72

C is correct. Tactical asset allocation involves timing investments in asset classes and does not make use of industry analysis.

Question 73

Which industry classification system uses a three-tier classification system?
A.Russell Global Sectors.
B.Industry Classification Benchmark.
C.Global Industry Classification Standard.

Answer 73

A is correct. The Russell system uses three tiers, whereas the other two systems are based on four tiers or levels.

Question 74

Which of the following statements about commercial and government industry classification systems is most accurate?
A.Many commercial classification systems include private for-profit companies.
B.Both commercial and government classification systems exclude not-for-profit companies.
C.Commercial classification systems are generally updated more frequently than government classification systems.

Answer 74

C is correct. Commercial systems are generally updated more frequently than government systems, and include only publicly traded for-profit companies.

Question 75

Which of the following is not a limitation of the cyclical/non-cyclical descriptive approach to classifying companies?
A.A cyclical company may have a growth component in it.
B.Business-cycle sensitivity is a discrete phenomenon rather than a continuous spectrum.
C.A global company can experience economic expansion in one part of the world while experiencing recession in another part.

Answer 75

B is correct. Business-cycle sensitivity falls on a continuum and is not a discrete “either–or” phenomenon.

Question 76

A company that is sensitive to the business cycle would most likely:
A.not have growth opportunities.
B.experience below-average fluctuation in demand.
C.sell products that the customer can purchase at a later date if necessary.

Answer 76

C is correct. Customers’ flexibility as to when they purchase the product makes the product more sensitive to the business cycle.

Question 77

Which of the following factors would most likely be a limitation of applying business-cycle analysis to global industry analysis?
A.Some industries are relatively insensitive to the business cycle.
B.Correlations of security returns between different world markets are relatively low.
C.One region or country of the world may experience recession while another region experiences expansion.

Answer 77

C is correct. Varying conditions of recession or expansion around the world would affect the comparisons of companies with sales in different regions of the world.

Question 78

Which of the following statements about peer groups is most accurate?
A.Constructing a peer group for a company follows a standardized process.
B.Commercial industry classification systems often provide a starting point for constructing a peer group.
C.A peer group is generally composed of all the companies in the most narrowly defined category used by the commercial industry classification system.

Answer 78

B is correct. Constructing a peer group is a subjective process, and a logical starting point is to begin with a commercially available classification system. This system will identify a group of companies that may have properties comparable to the business activity of interest.

Question 79

Which of the following life-cycle phases is typically characterized by high prices?
A.Mature.
B.Growth.
C.Embryonic.

Answer 79

C is correct. The embryonic stage is characterized by slow growth and high prices.

Question 80

When graphically depicting the life-cycle model for an industry as a curve, the variables on the axes are:
A.price and time.
B.demand and time.
C.demand and stage of the life cycle.

Answer 80

B is correct. The industry life-cycle model shows how demand evolves through time as an industry passes from the embryonic stage through the stage of decline.

Question 81

Which of the following is most likely a characteristic of a concentrated industry?
A.Infrequent, tacit coordination.
B.Difficulty in monitoring other industry members.
C.Industry members attempting to avoid competition on price.

Answer 81

C is correct. The relatively few members of the industry generally try to avoid price competition.

Question 82

An industry with high barriers to entry and weak pricing power most likely has:
A.high barriers to exit.
B.stable market shares.
C.significant numbers of issued patents.

Answer 82

A is correct. An industry that has high barriers to entry generally requires substantial physical capital and/or financial investment. With weak pricing power in the industry, finding a buyer for excess capacity (i.e., to exit the industry) may be difficult.

Question 83

Which of the following is not one of Porter’s five forces?
A.Intensity of rivalry.
B.Bargaining power of suppliers.
C.Threat of government intervention.

Answer 83

C is correct. Although the threat of government intervention may be considered an element of some of Porter’s five forces, it is not one of the listed forces.

Question 84

Which of the following industries is most likely to be characterized as concentrated with strong pricing power?
A.Asset management.
B.Alcoholic beverages.
C.Household and personal products.

Answer 84

B is correct. As displayed in Exhibit 4, the alcoholic beverage industry is concentrated and possesses strong pricing power.

Question 85

Which of the following industries is most likely to be considered to have the lowest barriers to entry?
A.Oil services.
B.Confections and candy.
C.Branded pharmaceuticals.

Answer 85

A is correct. The oil services industry has medium barriers to entry because a company with a high level of technological innovation could obtain a niche market in a specific area of expertise.

Question 86

When conducting a company analysis, the analysis of demand for a company’s product is least likely to consider the:
A.company’s cost structure.
B.motivations of the customer base.
C.product’s differentiating characteristics.

Answer 86

A is correct. The cost structure is an appropriate element when analyzing the supply of the product, but analysis of demand relies on the product’s differentiating characteristics and the customers’ needs and wants.

Question 87

Os 3 Modelos para determinar o valor intrinseco de equity

Answer 87

•Present value models (synonym: discounted cash flow models). These models estimate the intrinsic value of a security as the present value of the future benefits expected to be received from the security. In present value models, benefits are often defined in terms of cash expected to be distributed to shareholders (dividend discount models) or in terms of cash flows available to be distributed to shareholders after meeting capital expenditure and working capital needs (free-cash-flow-to-equity models). Many models fall within this category, ranging from the relatively simple to the very complex. In Section 4, we discuss in detail two of the simpler models, the Gordon (constant) growth model and the two-stage dividend discount models.

Multiplier models (synonym: market multiple models). These models are based chiefly on share price multiples or enterprise value multiples. The former model estimates intrinsic value of a common share from a price multiple for some fundamental variable, such as revenues, earnings, cash flows, or book value. Examples of the multiples include price to earnings (P/E, share price divided by earnings per share) and price to sales (P/S, share price divided by sales per share). The fundamental variable may be stated on a forward basis (e.g., forecasted EPS for the next year) or a trailing basis (e.g., EPS for the past year), as long as the usage is consistent across companies being examined. Price multiples are also used to compare relative values. The use of the ratio of share price to EPS—that is, the P/E multiple—to judge relative value is an example of this approach to equity valuation. 
Enterprise value (EV) multiples have the form (Enterprise value)/(Value of a fundamental variable). Two possible choices for the denominator are earnings before interest, taxes, depreciation, and amortization (EBITDA) and total revenue. Enterprise value, the numerator, is a measure of a company’s total market value from which cash and short-term investments have been subtracted (because an acquirer could use those assets to pay for acquiring the company). An estimate of common share value can be calculated indirectly from the EV multiple; the value of liabilities and preferred shares can be subtracted from the EV to arrive at the value of common equity. 

•Asset-based valuation models. These models estimate intrinsic value of a common share from the estimated value of the assets of a corporation minus the estimated value of its liabilities and preferred shares. The estimated market value of the assets is often determined by making adjustments to the book value (synonym: carrying value) of assets and liabilities. The theory underlying the asset-based approach is that the value of a business is equal to the sum of the value of the business’s assets.

Question 88

FCFE como é calculado

Answer 88

CF Operacional+ net borrowing - Fixed Cash flow Invested

Question 89

Two investors with different holding periods but the same expectations and required rate of return for a company are estimating the intrinsic value of a common share of the company. The investor with the shorter holding period will most likely estimate a:

A.lower intrinsic value.
B.higher intrinsic value.
C.similar intrinsic value.

Answer 89

C is correct. The intrinsic value of a security is independent of the investor’s holding period.

Question 90

Como é calculada a taxa de crescimento sustentável para uma empresa g?

Answer 90

b*ROE

b- dividend retention rate

Question 91

The current dividend, D0, is $5.00. Growth is expected to be 10 percent a year for three years and then 5 percent thereafter. The required rate of return is 15 percent. Estimate the intrinsic value.

Answer 91

D1 = $5.00(1 + 0.10) = $5.50 
D2 = $5.00(1 + 0.10)2 = $6.05 
D3 = $5.00(1 + 0.10)3 = $6.655 
D4 = $5.00(1 + 0.10)3 (1 + 0.05) = $6.98775 

V3=$6.987750.15−0.05=$69.8775

V0=$5.50(1+0.15)+$6.05(1+0.15)2+$6.655(1+0.15)3+$69.8775(1+0.15)3≈$59.68

Question 92

Geralmente para o DDM quantas fazes se assumem na prática?

Answer 92

3 fases, crescimento, shakeout e maturity, para essas fazes usamos g’s diferentes. sendo que usamos Gordon para a maturity

Question 93

EV =cost of takeover, how it is calculated?

Answer 93

market cap + market value of preferred stock+ market value of debt - Cash & Investments

Question 94

•In asset-based valuation models, the intrinsic value of a common share of stock is based on the:
A.estimated market value of the company’s assets.
B.estimated market value of the company’s assets plus liabilities.
C.estimated market value of the company’s assets minus liabilities.

Answer 94

C is correct. Asset-based valuation models calculate the intrinsic value of equity by subtracting liabilities from the market value of assets.

Question 95

•Which of the following is most likely used in a present value model?
A.Enterprise value.
B.Price to free cash flow.
C.Free cash flow to equity.

Answer 95

C is correct. It is a form of present value, or discounted cash flow, model. Both EV and FCFE are forms of multiplier models.

Question 96

An analyst is attempting to calculate the intrinsic value of a company and has gathered the following company data: EBITDA, total market value, and market value of cash and short-term investments, liabilities, and preferred shares. The analyst is least likely to use:
A.a multiplier model.
B.a discounted cash flow model.
C.an asset-based valuation model.

Answer 96

•B is correct. To use a discounted cash flow model, the analyst will require FCFE or dividend data. In addition, the analyst will need data to calculate an appropriate discount rate.

Question 97

An analyst who bases the calculation of intrinsic value on dividend-paying capacity rather than expected dividends will most likely use the:
A.dividend discount model.
B.free cash flow to equity model.
C.cash flow from operations model.

Answer 97

•B is correct. The FCFE model assumes that dividend-paying capacity is reflected in FCFE.

Question 98

In the free cash flow to equity (FCFE) model, the intrinsic value of a share of stock is calculated as:
A.the present value of future expected FCFE.
B.the present value of future expected FCFE plus net borrowing.
C.the present value of future expected FCFE minus fixed capital investment.

Answer 98

A is correct. In the FCFE model, the intrinsic value of stock is calculated by discounting expected future FCFE to present value. No further adjustments are required.

Question 99

A Canadian life insurance company has an issue of 4.80 percent, $25 par value, perpetual, non-convertible, non-callable preferred shares outstanding. The required rate of return on similar issues is 4.49 percent. The intrinsic value of a preferred share is closest to:
A.$25.00.
B.$26.75.
C.$28.50.

Answer 99

B is correct. The expected annual dividend is 4.80% × $25 = $1.20. The value of a preferred share is $1.20/0.0449 = $26.73.

Question 100

The Beasley Corporation has just paid a dividend of $1.75 per share. If the required rate of return is 12.3 percent per year and dividends are expected to grow indefinitely at a constant rate of 9.2 percent per year, the intrinsic value of Beasley Corporation stock is closest to:
A.$15.54.
B.$56.45.
C.$61.65.

Answer 100

C is correct. P0 = D1/(r – g) = 1.75(1.092)/(0.123 – 0.092) = $61.65.

Question 101

An investor is considering the purchase of a common stock with a $2.00 annual dividend. The dividend is expected to grow at a rate of 4 percent annually. If the investor’s required rate of return is 7 percent, the intrinsic value of the stock is closest to:
A.$50.00.
B.$66.67.
C.$69.33.

Answer 101

C is correct. According to the Gordon growth model, V0 = D1/(r – g). In this case, D1  = $2.00 × 1.04 = $2.08, so V0 = $2.08/(0.07 – 0.04) = $69.3333 = $69.33.

Question 102

An analyst gathers or estimates the following information about a stock:

Current price per share €22.56
Current annual dividend per share €1.60
Annual dividend growth rate for Years 1–4 9.00%
Annual dividend growth rate for Years 5+ 4.00%
Required rate of return 12%

Based on a dividend discount model, the stock is most likely:
A.undervalued.
B.fairly valued.
C.overvalued.

Answer 102

A is correct. The current price of €22.56 is less than the intrinsic value (V0) of €24.64; therefore, the stock appears to be currently undervalued. According to the two-stage dividend discount model:

V0=∑t=1nD0(1+gS)t(1+r)t+Vn(1+r)n

and
Vn=Dn+1r−gL

Dn+1 = D0(1 + gS)n(1 + gL)

D1 = €1.60 × 1.09 = €1.744

D2 = €1.60 × (1.09)2 = €1.901

D3 = €1.60 × (1.09)3 = €2.072

D4 = €1.60 × (1.09)4 = €2.259

D5 = €1.60 × (1.09)4 = €2.349

V4 = €2.349/(0.12 – 0.04) = €29.363

V0=1.744(1.12)1+1.901(1.12)2+2.072(1.12)3+2.259(1.12)4+29.363(1.12)4=1.557+1.515+1.475+1.436+18.661=€24.64(whichisgreaterthanthecurrentpriceof€22.56).

Question 103

•An analyst is attempting to value shares of the Dominion Company. The company has just paid a dividend of $0.58 per share. Dividends are expected to grow by 20 percent next year and 15 percent the year after that. From the third year onward, dividends are expected to grow at 5.6 percent per year indefinitely. If the required rate of return is 8.3 percent, the intrinsic value of the stock is closest to:
A.$26.00.
B.$27.00.
C.$28.00.

Answer 103

C is correct.

V0=D1(1+r)+D2(1+r)2+P2(1+r)2=0.70(1.083)+0.80(1.083)2+31.29(1.083)2=$28.01

Note that D1 = 0.58(1.20) = 0.70, D2 = 0.58(1.20)(1.15) = 0.80, and P2 = D3/(k – g) = 0.80(1.056)/(0.083 – 0.056) = 31.29

Question 104

•Hideki Corporation has just paid a dividend of ¥450 per share. Annual dividends are expected to grow at the rate of 4 percent per year over the next four years. At the end of four years, shares of Hideki Corporation are expected to sell for ¥9000. If the required rate of return is 12 percent, the intrinsic value of a share of Hideki Corporation is closest to:
A.¥5,850.
B.¥7,220.
C.¥7,670.

Answer 104

B is correct.

V0=D1(1+r)+ D2(1+r)2+D3(1+r)3+D4(1+r)4+ P4(1+r)4=468(1.12)+486.72(1.12)2+ 506.19(1.12)3+526.44(1.12)4+9000 (1.12)4=¥7,220

Question 105

•The Gordon growth model can be used to value dividend-paying companies that are:
A.expected to grow very fast.
B.in a mature phase of growth.
C.very sensitive to the business cycle.

Answer 105

B is correct. The Gordon growth model (also known as the constant growth model) can be used to value dividend-paying companies in a mature phase of growth. A stable dividend growth rate is often a plausible assumption for such companies.

Question 106

•The best model to use when valuing a young dividend-paying company that is just entering the growth phase is most likely the:
A.Gordon growth model.
B.two-stage dividend discount model.
C.three-stage dividend discount model.

Answer 106

C is correct. The Gordon growth model is best suited to valuing mature companies. The two-stage model is best for companies that are transitioning from a growth stage to a mature stage. The three-stage model is appropriate for young companies just entering the growth phase.

Question 107

A price earnings ratio that is derived from the Gordon growth model is inversely related to the:
A.growth rate.
B.dividend payout ratio.
C.required rate of return.

Answer 107

C is correct. The justified forward P/E is calculated as follows:

P0E1=D1E1r−g

P/E is inversely related to the required rate of return, r, and directly related to the growth rate, g, and the dividend payout ratio, D/E.

Question 108

An analyst makes the following statement: “Use of P/E and other multiples for analysis is not effective because the multiples are based on historical data and because not all companies have positive accounting earnings.” The analyst’s statement is most likely:
A.inaccurate with respect to both historical data and earnings.
B.accurate with respect to historical data and inaccurate with respect to earnings.
C.inaccurate with respect to historical data and accurate with respect to earnings.

Answer 108

A is correct. The statement is inaccurate in both respects. Although multiples can be calculated from historical data, forecasted values can be used as well. For companies without accounting earnings, several other multiples can be used. These multiples are often specific to a company’s industry or sector and include price-to-sales and price-to-cash flow.

Question 109

An analyst has gathered the following information for the Oudin Corporation:
Expected earnings per share = €5.70
Expected dividends per share = €2.70
Dividends are expected to grow at 2.75 percent per year indefinitely
The required rate of return is 8.35 percent
Based on the information provided, the price/earnings multiple for Oudin is closest to:
A.5.7.
B.8.5.
C.9.4.

Answer 109

B is correct.

P0E1=D1E1r−g=2.75.70.0835−0.0275=8.5

Question 110

The market value of equity for a company can be calculated as enterprise value:
A.minus market value of debt, preferred stock, and short-term investments.
B.plus market value of debt and preferred stock minus short-term investments.
C.minus market value of debt and preferred stock plus short-term investments.

Answer 110

•C is correct. Enterprise value is calculated as the market value of equity plus the market value of debt and preferred stock minus short-term investments. Therefore, the market value of equity is enterprise value minus the market value of debt and preferred stock plus short-term investments.

Question 111

•Which of the following statements regarding the calculation of the enterprise value multiple is most likely correct?
A.Operating income may be used instead of EBITDA.
B.EBITDA may not be used if company earnings are negative.
C.Book value of debt may be used instead of market value of debt.

Answer 111

•A is correct. Operating income may be used in place of EBITDA when calculating the enterprise value multiple. EBITDA may be used when company earnings are negative because EBITDA is usually positive. The book value of debt cannot be used in place of market value of debt.

Question 112

•An analyst has determined that the appropriate EV/EBITDA for Rainbow Company is 10.2. The analyst has also collected the following forecasted information for Rainbow Company:
EBITDA = $22,000,000
Market value of debt = $56,000,000
Cash = $1,500,000

Answer 112

•A is correct.
EV = 10.2 × 22,000,000 = $224,400,000

Equity value = EV – Debt + Cash
= 224,400,000 – 56,000,000 + 1,500,000
= $169,900,000

Question 113

•Asset-based valuation models are best suited to companies where the capital structure does not have a high proportion of:
A.debt.
B.intangible assets.
C.current assets and liabilities.

Answer 113

•B is correct. Intangible assets are hard to value. Therefore, asset-based valuation models work best for companies that do not have a high proportion of intangible assets.

Question 114

•Which of the following is most likely a reason for using asset-based valuation?
A.The analyst is valuing a privately held company.
B.The company has a relatively high level of intangible assets.
C.The market values of assets and liabilities are different from the balance sheet values.

Answer 114

•A is correct. Asset-based valuations are most often used when an analyst is valuing private enterprises. Both B and C are considerations in asset-based valuations but are more likely to be reasons to avoid that valuation model rather than reasons to use it.

Question 115

Which of the following is most likely considered a weakness of present value models?
A.Present value models cannot be used for companies that do not pay dividends.
B.Small changes in model assumptions and inputs can result in large changes in the computed intrinsic value of the security.
C.The value of the security depends on the investor’s holding period; thus, comparing valuations of different companies for different investors is difficult.

Answer 115

B is correct. Very small changes in inputs, such as required rate of return or dividend growth rate, can result in large changes to the valuation model output. Some present value models, such as FCFE models, can be used to value companies without dividends. Also, the intrinsic value of a security is independent of the investor’s holding period.

Question 116

current yield =?

ytm

Answer 116

coupon/preço

ytm é a taxa que se irá obter com a atualizaçao dos CF da obrigação até à maturidade

Question 117

•The term most likely used to refer to the legal contract under which a bond is issued is:
A.indenture.
B.debenture.
C.letter of credit.

Answer 117

A is correct. The contract between a bond issuer and the bondholders is very often called an indenture or deed trust. The indenture documents the terms of the issue, including the principal amount, the coupon rate, and the payments schedule. It also provides information about the funding sources for the contractual payments and specifies whether there are any collateral, credit enhancement, or covenants. B is incorrect because a debenture is a type of bond. C is incorrect because a letter of credit is an external credit enhancement.

Question 118

•The individual or entity that most likely assumes the role of trustee for a bond issue is:
A.a financial institution appointed by the issuer.
B.the treasurer or chief financial officer of the issuer.
C.a financial institution appointed by a regulatory authority.

Answer 118

A is correct. The issuer chooses a financial institution with trust powers, such as the trust department of a bank or a trust company, to act as a trustee for the bond issue.

Question 119

•The individual or entity most likely responsible for the timely payment of interest and repayment of principal to bondholders is the:
A.trustee.
B.primary or lead bank of the issuer.
C.treasurer or chief financial officer of the issuer.

Answer 119

A is correct. Although the issuer is ultimately the source of the contractual payments, it is the trustee that ensures timely payments. Doing so is accomplished by invoicing the issuer for interest payments and principal repayments and holding the funds until they are paid.

Question 120

•The major advantage of issuing bonds through a special purpose vehicle is:
A.bankruptcy remoteness.
B.beneficial tax treatments.
C.greater liquidity and lower issuing costs.

Answer 120

A is correct. A SPV is a bankruptcy-remote vehicle. Bankruptcy remoteness is achieved by transferring the assets from the sponsor to the SPV. Once this transfer is completed, the sponsor no longer has ownership rights. If the sponsor defaults, no claims can be made to recover the assets that were transferred or the proceeds from the transfer to the SPV.

Question 121

•The category of bond most likely repaid from the repayment of previous loans made by the issuer is:
A.sovereign bonds.
B.supranational bonds.
C.non-sovereign bonds.

Answer 121

B is correct. The source of payment for bonds issued by supranational organizations is either the repayment of previous loans made by the organization or the paid-in capital of its member states. A is incorrect because national governments rely on their taxing authority and money creation to repay their debt. C is incorrect because non-sovereign bonds are typically repaid from the issuer’s taxing authority or the cash flows of the project being financed.

Question 122

•The type of collateral used to secure collateral trust bonds is most likely:
A.securities.
B.mortgages.
C.physical assets.

Answer 122

A is correct. Collateral trust bonds are secured by securities, such as common shares, other bonds, or other financial assets. B is incorrect because mortgage-backed securities are secured by mortgages. C is incorrect because equipment trust certificates are backed by physical assets such as aircraft, railroad cars, shipping containers, or oil rigs.

Question 123

•The external credit enhancement that has the least amount of third-party risk is a:
A.surety bond.
B.letter of credit.
C.cash collateral account.

Answer 123

C is correct. The third-party (or counterparty) risk for a surety bond and a letter of credit arises from both being future promises to pay. In contrast, a cash collateral account allows the issuer to immediately borrow the credit-enhancement amount and then invest it.

Question 124

•An example of an affirmative covenant is the requirement:
A.that dividends will not exceed 60% of earnings.
B.to insure and perform periodic maintenance on financed assets.
C.that the debt-to-equity ratio will not exceed 0.4 and times interest earned will not fall below 8.0.

Answer 124

B is correct. Affirmative covenants indicate what the issuer “must do” and are administrative in nature. A covenant requiring the issuer to insure and perform periodic maintenance on financed assets is an example of affirmative covenant. A and C are incorrect because they are negative covenants; they indicate what the issuer cannot do.

Question 125

•An example of a covenant that protects bondholders against the dilution of their claims is a restriction on:
A.debt.
B.investments.
C.mergers and acquisitions.

Answer 125

A is correct. A restriction on debt typically takes the form of a maximum acceptable debt usage ratio or a minimum acceptable interest coverage ratio. Thus, it limits the issuer’s ability to issue new debt that would dilute the bondholders’ claims. B and C are incorrect because they are covenants that restrict the issuer’s business activities by preventing the company from making investments or being taken over, respectively.

Question 126

•An example of a domestic bond is a bond issued by:
A.LG Group from South Korea, denominated in British pounds, and sold in the United Kingdom.
B.the UK Debt Management Office, denominated in British pounds, and sold in the United Kingdom.
C.Wal-Mart from the United States, denominated in US dollars, and sold in various countries in North America, Europe, the Middle East, and Asia Pacific.

•A bond issued by Sony in Japan, denominated in US dollars but not registered with the SEC, and sold to an institutional investor in the Middle East, is most likely an example of a:
A.Eurobond.
B.global bond.
C.foreign bond.

Answer 126

Solution to 1:

B is correct. A domestic bond is issued by a local issuer, denominated in local currency, and sold in the domestic market. Gilts are British pound–­denominated bonds issued by the UK Debt Management Office in the United Kingdom. Thus, they are UK domestic bonds. A is incorrect because a bond issued by LG Group from South Korea, denominated in British pounds, and sold in the United Kingdom, is an example of a foreign bond (bulldog bond). C is incorrect because a bond issued by Wal-Mart from the United States, denominated in US dollars, and sold in various countries in North America, Europe, the Middle East, and Asia Pacific is most likely an example of a global bond, particularly if it is also sold in the Eurobond market.

Solution to 2:

A is correct. A Eurobond is a bond that is issued internationally, outside the jurisdiction of any single country. Thus, a bond issued by Sony from Japan, denominated in US dollars but not registered with the SEC, is an example of a Eurobond. B is incorrect because global bonds are bonds that are issued simultaneously in the Eurobond market and in at least one domestic bond market. C is incorrect because if Sony’s bond issue were a foreign bond (Yankee bond), it would be registered with the SEC.

Question 127

•Floating-rate notes most likely pay:
A.annual coupons.
B.quarterly coupons.
C.semi-annual coupons.

Answer 127

B is correct. Most FRNs pay interest quarterly and are tied to a three-month reference rate such as Libor.

Question 128

•A zero-coupon bond can best be considered a:
A.step-up bond.
B.credit-linked bond.
C.deferred coupon bond.

Answer 128

C is correct. Because interest is effectively deferred until maturity, a zero-coupon bond can be thought of as a deferred coupon bond. A and B are incorrect because both step-up bonds and credit-linked bonds pay regular coupons. For a step-up bond, the coupon increases by specified margins at specified dates. For a credit-linked bond, the coupon changes when the bond’s credit rating changes.

Question 129

•The bonds that do not offer protection to the investor against increases in market interest rates are:
A.step-up bonds.
B.floating rate notes.
C.inverse floating rate notes.

Answer 129

C is correct. The coupon rate on an inverse FRN has an inverse relationship to the reference rate. Thus, an inverse FRN does not offer protection to the investor when market interest rates increase but when they decrease. A and B are incorrect because step-up bonds and FRNs both offer protection against increases in market interest rates.

Question 130

The US Treasury offers Treasury Inflation-Protected Securities (TIPS). The principal of TIPS increases with inflation and decreases with deflation based on changes in the US Consumer Price Index. When TIPS mature, an investor is paid the original principal or inflation-adjusted principal, whichever is greater. TIPS pay interest twice a year based on a fixed real coupon rate that is applied to the inflation-adjusted principal. TIPS are most likely:
A.capital-indexed bonds.
B.interest-indexed bonds.
C.indexed-annuity bonds.

Answer 130

A is correct. TIPS have a fixed coupon rate, and the principal is adjusted based on changes in the CPI. Thus, TIPS are an example of capital-indexed bonds. B is incorrect because with an interest-index bond, it is the principal repayment at maturity that is fixed and the coupon that is linked to an index. C is incorrect because indexed-annuity bonds are fully amortized bonds, not bullet bonds. The annuity payment (interest payment and principal repayment) is adjusted based on changes in an index.

Question 131

•Assume a hypothetical country, Lemuria, where the national government has issued 20-year capital-indexed bonds linked to the domestic Consumer Price Index (CPI). Lemuria’s economy has been free of inflation until the most recent six months, when the CPI increased. Following the increase in inflation:
A.the principal amount remains unchanged but the coupon rate increases.
B.the coupon rate remains unchanged but the principal amount increases.
C.the coupon payment remains unchanged but the principal amount increases.

Answer 131

B is correct. Following an increase in inflation, the coupon rate of a capital-indexed bond remains unchanged, but the principal amount is adjusted upward for inflation. Thus, the coupon payment, which is equal to the fixed coupon rate multiplied by the inflation-adjusted principal amount, increases.

Question 132

Convertible bonds…
what is conversion ratio and how do you calculate it?

Conversion Value?

Answer 132

The conversion ratio is the number of common shares that each bond can be converted into. The indenture sometimes does not stipulate the conversion ratio but only mentions the conversion price. The conversion ratio is equal to the par value divided by the conversion price. For example, if the par value is 1,000€ and the conversion price is 20€, the conversion ratio is 1,000€ ÷ 20€ = 50:1, or 50 common shares per bond.

The conversion value, sometimes called the parity value, is the current share price multiplied by the conversion ratio. For example, if the current share price is 33€ and the conversion ratio is 30:1, the conversion value is 33€ × 30 = 990€.

Question 133

Contingent convertible bonds, nicknamed “CoCos,”

Answer 133

Two main features distinguish bonds with contingent write-down provisions from the traditional convertible bonds just described. A traditional convertible bond is convertible at the option of the bondholder, and conversion occurs on the upside—that is, if the issuer’s share price increases. In contrast, bonds with contingent write-down provisions are convertible on the downside. In the case of CoCos, conversion is automatic if a specified event occurs—for example, if the bank’s core Tier 1 capital ratio (a measure of the bank’s proportion of core equity capital available to absorb losses) falls below the minimum requirement set by the regulators. Thus, in the event that the bank experiences losses that reduce its equity capital below the minimum requirement, CoCos are a way to reduce the bank’s likelihood of default and, therefore, systemic risk—that is, the risk of failure of the financial system. When the bank’s core Tier 1 capital falls below the minimum requirement, the CoCos immediately convert into equity, automatically recapitalizing the bank, lightening the debt burden, and reducing the risk of default. Because the conversion is not at the option of the bondholders but automatic, CoCos force bondholders to take losses. For this reason, CoCos must offer a higher yield than otherwise similar bonds.

Question 134

Assume that a convertible bond issued in South Korea has a par value of ₩1,000,000 and is currently priced at ₩1,100,000. The underlying share price is ₩40,000 and the conversion ratio is 25:1. The conversion condition for this bond is:
A.parity.
B.above parity.
C.below parity.

Answer 134

C is correct. The conversion value of the bond is ₩40,000 × 25 = ₩1,000,000. The price of the convertible bond is ₩1,100,000. Thus, the conversion value of the bond is less than the bond’s price, and this condition is referred to as below parity.

Question 135

Amortizing Bond

Bullet Bond

Ballon Payment

Answer 135

Amortizing Bond, vai amortizando o principal até à maturidade.

Bullet Bond paga a totalidade do principal na maturidade

Ballon Payment é um pagamento de parte do principal na maturidade.

Question 136

Sinking fund arrangement

FRN - floating rate note

Answer 136

A sinking fund arrangement is another approach that can be used to achieve the same goal of periodically retiring the bond’s principal outstanding. The term sinking fund refers to an issuer’s plans to set aside funds over time to retire the bond. Originally, a sinking fund was a specified cash reserve that was segregated from the rest of the issuer’s business for the purpose of repaying the principal. More generally today, a sinking fund arrangement specifies the portion of the bond’s principal outstanding, perhaps 5%, that must be repaid each year throughout the bond’s life or after a specified date. This repayment occurs whether or not an actual segregated cash reserve has been created.

Question 137

Payment structures for index-linked:

• Zero-coupon-indexed bonds
• Interest-indexed bonds
• Capital-indexed bonds
• Indexed-annuity bonds

Answer 137

• Zero-coupon-indexed bonds pay no coupon, so the inflation adjustment is made via the principal repayment only: The principal amount to be repaid at maturity increases in line with increases in the price index during the bond’s life. This type of bond has been issued in Sweden.
• Interest-indexed bonds pay a fixed nominal principal amount at maturity but an index-linked coupon during the bond’s life. Thus, the inflation adjustment applies to the interest payments only. This type of bond was briefly issued by the Australian government in the late 1980s, but it never became a significant part of the inflation-linked bond market.
• Capital-indexed bonds pay a fixed coupon rate but it is applied to a principal amount that increases in line with increases in the index during the bond’s life. Thus, both the interest payments and the principal repayment are adjusted for inflation. Such bonds have been issued by governments in Australia, Canada, New Zealand, the United Kingdom, and the United States.
• Indexed-annuity bonds are fully amortized bonds, in contrast to interest-indexed and capital-indexed bonds that are non-amortizing coupon bonds. The annuity payment, which includes both payment of interest and repayment of the principal, increases in line with inflation during the bond’s life. Indexed-annuity bonds linked to a price index have been issued by local governments in Australia, but not by the national government.

Question 138

A 10-year bond was issued four years ago. The bond is denominated in US dollars, offers a coupon rate of 10% with interest paid semi-annually, and is currently priced at 102% of par. The bond’s:
A.tenor is six years.
B.nominal rate is 5%.
C.redemption value is 102% of the par value.

Answer 138

A is correct. The tenor of the bond is the time remaining until the bond’s maturity date. Although the bond had a maturity of 10 years at issuance (original maturity), it was issued four years ago. Thus, there are six years remaining until the maturity date.
B is incorrect because the nominal rate is the coupon rate, i.e., the interest rate that the issuer agrees to pay each year until the maturity date. Although interest is paid semi-annually, the nominal rate is 10%, not 5%. C is incorrect because it is the bond’s price, not its redemption value (also called principal amount, principal value, par value, face value, nominal value, or maturity value), that is equal to 102% of the par value.

Question 139

A company has issued a floating-rate note with a coupon rate equal to the three-month Libor + 65 basis points. Interest payments are made quarterly on 31 March, 30 June, 30 September, and 31 December. On 31 March and 30 June, the three-month Libor is 1.55% and 1.35%, respectively. The coupon rate for the interest payment made on 30 June is:
A.2.00%.
B.2.10%.
C.2.20%.

Answer 139

C is correct. The coupon rate that applies to the interest payment due on 30 June is based on the three-month Libor rate prevailing on 31 March. Thus, the coupon rate is 1.55% + 0.65% = 2.20%.

Question 140

Which of the following is a type of external credit enhancement?
A.Covenants
B.A surety bond
C.Overcollaterization

Answer 140

B is correct. A surety bond is an external credit enhancement, i.e., a guarantee received from a third party. If the issuer defaults, the guarantor who provided the surety bond will reimburse investors for any losses, usually up to a maximum amount called the penal sum.
A is incorrect because covenants are legally enforceable rules that borrowers and lenders agree upon when the bond is issued. C is incorrect because overcollateralization is an internal, not external, credit enhancement. Collateral is a guarantee underlying the debt above and beyond the issuer’s promise to pay, and overcollateralization refers to the process of posting more collateral than is needed to obtain or secure financing. Collateral, such as assets or securities pledged to ensure debt payments, is not provided by a third party. Thus, overcollateralization is not an external credit enhancement.

Question 141

An affirmative covenant is most likely to stipulate:
A.limits on the issuer’s leverage ratio.
B.how the proceeds of the bond issue will be used.
C.the maximum percentage of the issuer’s gross assets that can be sold.

Answer 141

B is correct. Affirmative (or positive) covenants enumerate what issuers are required to do and are typically administrative in nature. A common affirmative covenant describes what the issuer intends to do with the proceeds from the bond issue.
A and C are incorrect because imposing a limit on the issuer’s leverage ratio or on the percentage of the issuer’s gross assets that can be sold are negative covenants. Negative covenants prevent the issuer from taking actions that could reduce its ability to make interest payments and repay the principal.

Question 142

A South African company issues bonds denominated in pound sterling that are sold to investors in the United Kingdom. These bonds can be best described as:
A.Eurobonds.
B.global bonds.
C.foreign bonds.

Answer 142

•C is correct. Bonds sold in a country and denominated in that country’s currency by an entity from another country are referred to as foreign bonds.
A is incorrect because Eurobonds are bonds issued outside the jurisdiction of any single country. B is incorrect because global bonds are bonds issued in the Eurobond market and at least one domestic country simultaneously.
greater, regulation than domestic and foreign bonds.

Question 143

Relative to domestic and foreign bonds, Eurobonds are most likely to be:
A.bearer bonds.
B.registered bonds.
C.subject to greater regulation.

Answer 143

•A is correct. Eurobonds are typically issued as bearer bonds, i.e., bonds for which the trustee does not keep records of ownership. In contrast, domestic and foreign bonds are typically registered bonds for which ownership is recorded by either name or serial number.
B is incorrect because Eurobonds are typically issued as bearer bonds, not registered bonds. C is incorrect because Eurobonds are typically subject to lower, not

Question 144

An investor in a country with an original issue discount tax provision purchases a 20-year zero-coupon bond at a deep discount to par value. The investor plans to hold the bond until the maturity date. The investor will most likely report:
A.a capital gain at maturity.
B.a tax deduction in the year the bond is purchased.
C.taxable income from the bond every year until maturity.

Answer 144

•C is correct. The original issue discount tax provision requires the investor to include a prorated portion of the original issue discount in his taxable income every tax year until maturity. The original issue discount is equal to the difference between the bond’s par value and its original issue price.
A is incorrect because the original issue discount tax provision allows the investor to increase his cost basis in the bond so that when the bond matures, he faces no capital gain or loss. B is incorrect because the original issue discount tax provision does not require any tax deduction in the year the bond is purchased or afterwards.

Question 145

If interest rates are expected to increase, the coupon payment structure most likely to benefit the issuer is a:
A.step-up coupon.
B.inflation-linked coupon.
C.cap in a floating-rate note.

Answer 145

C is correct. A cap in a floating-rate note (capped FRN) prevents the coupon rate from increasing above a specified maximum rate. This feature benefits the issuer in a rising interest rate environment because it sets a limit to the interest rate paid on the debt.
A is incorrect because a bond with a step-up coupon is one in which the coupon, which may be fixed or floating, increases by specified margins at specified dates. This feature benefits the bondholders, not the issuer, in a rising interest rate environment because it allows bondholders to receive a higher coupon in line with the higher market interest rates. B is incorrect because inflation-linked bonds have their coupon payments and/or principal repayment linked to an index of consumer prices. If interest rates increase as a result of inflation, this feature is a benefit for the bondholders, not the issuer.

Question 146

A 10-year, capital-indexed bond linked to the Consumer Price Index (CPI) is issued with a coupon rate of 6% and a par value of 1,000. The bond pays interest semi-annually. During the first six months after the bond’s issuance, the CPI increases by 2%. On the first coupon payment date, the bond’s:
A.coupon rate increases to 8%.
B.coupon payment is equal to 40.
C.principal amount increases to 1,020.

Answer 146

C is correct. Capital-indexed bonds pay a fixed coupon rate that is applied to a principal amount that increases in line with increases in the index during the bond’s life. If the consumer price index increases by 2%, the coupon rate remains unchanged at 6%, but the principal amount increases by 2% and the coupon payment is based on the inflation-adjusted principal amount. On the first coupon payment date, the inflation-adjusted principal amount is 1,000 × (1 + 0.02) = 1,020 and the semi-annual coupon payment is equal to (0.06 × 1,020) ÷ 2 = 30.60.

Question 147

Syndicated offering

Answer 147

It is more common for larger bond issues, however, to be underwritten by a group, or syndicate, of investment banks. In this case, the bond issue is referred to as a syndicated offering.

Question 148

Primary market offerings:

Underwritten Offerings

Shelf registration (primary markets offering)

Auctions

Answer 148

When an investment bank underwrites a bond issue, it buys the entire issue and takes the risk of reselling it to investors or dealers. In contrast, in a best efforts offering, the investment bank serves only as a broker and sells the bond issue only if it is able to do so. Underwritten and best effort offerings are frequently used in the issuance of corporate bonds.

• A shelf registration is a method for issuing securities in which the issuer files a single document with regulators that describes a range of future issuances.
• An auction is a public offering method that involves bidding, and that is helpful in providing price discovery and in allocating securities. It is frequently used in the issuance of sovereign bonds.

Question 149

Corporate bonds will most likely settle on the:
A.trade date.
B.trade date plus one day.
C.trade date plus three days.

Answer 149

C is correct. Corporate bonds typically settle on a T + 3 basis—that is, three days after the transaction date. A is incorrect because cash settlement occurs for some government and quasi-government bonds and for many money market trades. B is incorrect because settlement on a T + 1 basis is typical for government, not corporate, bonds.

Question 150

Diferenças (currency, matutiry, interest, settlement)

USCP - Us comercial Paper

ECP - EuroComercial paper

Answer 150

The US commercial paper (USCP) market is the largest commercial paper market in the world, although there are other active commercial paper markets in other countries. Commercial paper issued in the international market is known as Eurocommercial paper (ECP). Although ECP is a similar instrument to USCP, there are some differences between the two.

                            USCP                                  ECP Currency:      US Dollar                          Any currency Maturity :      Overnight->270d             Overnight->364d Interest:        Discount basis              Interest Bearing basis Settlement:   T+0                                  T+2

Question 151

quasi government bond

non sovereign bond

Answer 151

non sovereign bond - municipal bonds, por vezes oferecem vantagens fiscais.

Quasi government bond- empresas detidas pelo estado p.e. O pagamento das obrigações vem dos cash flow das empresas.

Question 152

A loan made by a group of banks to a private company is most likely:
A.a bilateral loan.
B.a syndicated loan.
C.a private placement.

Answer 152

B is correct. A loan from a group of lenders to a single borrower is a syndicated loan. A is incorrect because a bilateral loan is a loan from a single lender to a single borrower. C is incorrect because a private placement involves placing the debt issued by a borrower directly with a lender or a group of lenders. The fact that the borrower is a private company is irrelevant.

Question 153

A bond issue that has a stated number of bonds that mature and are paid off each year before final maturity most likely has a:
A.term maturity.
B.serial maturity.
C.sinking fund arrangement.

Answer 153

B is correct. With a serial maturity structure, a stated number of bonds mature and are paid off each year before final maturity. A is incorrect because a bond issue with a term maturity structure is paid off in one lump sum at maturity. C is incorrect because a sinking fund arrangement, like a serial maturity structure, results in a portion of the bond issue being paid off every year. However, with a serial maturity structure, the bonds are paid off because the maturity dates are spread out during the life of the bond and the bonds that are retired are maturing; the bondholders know in advance which bonds will be retired. In contrast, the bonds retired annually with a sinking fund arrangement are designated by a random drawing.

Question 154

Reverse purchase agreement como é feito?

Answer 154

pedir emprestada uma securitie e dar como colateral o dinheiro ( short selling)?

Question 155

•A large-denomination negotiable certificate of deposit most likely:
A.is traded in the open market.
B.is purchased by retail investors.
C.has a penalty for early withdrawal of funds.

•From the dealer’s viewpoint, a repurchase agreement is best described as a type of:
A.collateralized short-term lending.
B.collateralized short-term borrowing.
C.uncollateralized short-term borrowing.

Answer 155

Solution to 3:
A is correct. Large-denomination negotiable certificates of deposit (CDs) can be traded in the open market. B is incorrect because it is small-denomination, not large-denomination, negotiable CDs that are primarily purchased by retail investors. C is incorrect because it is non-negotiable, not negotiable, CDs that have a penalty for early withdrawal of funds.

Solution to 4:
B is correct. In a repurchase agreement, a security is sold with a simultaneous agreement by the seller to buy the same security back from the purchaser later at a higher price. Thus, a repurchase agreement is similar to a collateralized short-term borrowing in which the security sold and subsequently repurchased represents the collateral posted. A is incorrect because collateralized short-term lending is a description of a reverse repurchase agreement. C is incorrect because a repurchase agreement involves collateral. Thus, it is a collateralized, not uncollateralized, short-term borrowing.

Question 156

Eurobond market

Answer 156

Based on where the bonds are issued and traded, a distinction is made between domestic and international bond markets. The latter includes the Eurobond market, which falls outside the jurisdiction of any single country and is characterized by less reporting, regulatory and tax constraints. Investors also make a distinction between developed and emerging bond markets.

Question 157

Medium term notes

Answer 157

Medium-term notes are securities that are offered continuously to investors by an agent of the issuer. They can have short-term or long-term maturities.

Question 158

Convexity effect on the price volatility on a bond

quais são os outros factores que dão volatilidade ao valor da obrigação?

Answer 158

For each bond, the percentage price increases are greater in absolute value than the percentage price decreases. This implies that the relationship between bond prices and the market discount rate is not linear; instead, it is curved. It is described as being “convex.” The convexity effect is shown in Exhibit 2 for a 10%, 10-year bond.

Quando a yield sobe o preço baixa, contudo o preço é mais sensível quanto mais baixa for a yield, daí que se a yield subir de 2% para 3% o efeito no preço é menor do que se a yield baixar de 2% para 1%.

• maturidade
• cupões mais baixos têm maior volatilidade

Question 159

what are spot rates?

How do you use spot rates?

Answer 159

Spot rates are yields-to-maturity on zero-coupon bonds maturing at the date of each cash flow

You can use spot rates to precification of bonds

Question 160

Calculate the price (per 100 of par value) and the yield-to-maturity for a four-year, 3% annual coupon payment bond given the following two sequences of spot rates.

             Spot Rates A                       Spot Rates B 1 year          0.39%                                    4.08% 2 years        1.40%                                    4.01% 3 years        2.50%                                   3.70% 4 years        3.60%                                   3.50%

(I

Answer 160

AAAAAA
The yield-to-maturity is 3.516%.

BBBBBBBBB
Given spot rates B, the four-year, 3% bond is again priced at 98.104 to yield 3.516%.

This example demonstrates that two very different sequences of spot rates can result in the same bond price and yield-to-maturity. Spot rates A are increasing for longer maturities, whereas spot rates B are decreasing.

Question 161

Para que é usado matrix pricing?

Answer 161

para avaliar obrigações iliquidas ou por imitir.

Para as obrigações seleccionadas para o calculo calculamos as yield médias por ano, yield média para 2 anos para 3, 4, etc.. posteriormente calculamos os anos que desejamos por intermpolação linear.

Question 162

what is a yield quoted on a semiannual bond basis?

Answer 162

It is a yield per semiannual period times two.

Question 163

Yield-to-worst como é calculada?

Answer 163

quando tempos uma callable bond podemos ser conservadores e assumir a yield to worst, esta é a pior yield entre todos os anos em que a obrigação poderia ser called e a maturidade.

Question 164

Money market instruments can be quoted on a discount rate or add on rate basis. How do you calculate following that basis?

Answer 164

Add On Rate
PV= 100 paga cupão na maturidade AOR= (diasAno/diasprod)*(FV-PV/PV)

discount rate
A obrigação é emitida a desconto sendo que o FV é 100.

Para compararmos diferentes emissões temos que usar o mesmo método ou calcular a AOR para todas as emissões.

Question 165

In the case of money market securities periodicity is…

Answer 165

equal to the lenght of the instrument =t/365 , u need to transform this periodicity to compare with others.

Question 166

G-spread, I - spread Z-spread

Answer 166

• A G-spread is the spread over or under a government bond rate, and an I-spread is the spread over or under an interest rate swap rate.
• A G-spread or an I-spread can be based on a specific benchmark rate or on a rate interpolated from the benchmark yield curve.
• A Z-spread (zero-volatility spread) is based on the entire benchmark spot curve. It is the constant spread that is added to each spot rate such that the present value of the cash flows matches the price of the bond.

Question 167

em ABS e MBS o que são os conceitos:

prepayment risk

time tranching

credit tranching

Answer 167

Prepayment risk is the uncertainty that the cash flows will be different from the scheduled cash flows as set forth in the loan agreement due to the borrowers’ ability to alter payments, usually to take advantage of interest rate movements.

Time tranching é a criação de diferentes tranches de ABS/MBS com diferentes maturidades.

credit tranching é a criação de diferentes tranches sendo que uma é subordinada e outra é sénior, as subordinadas assumem primeiro as perdas.

Question 168

Residential Mortgage Loans:

Loan-to-Value Ratio

Answer 168

loan-to-value ratio (LTV). The higher the LTV, the lower the borrower’s equity; the lower the LTV, the greater the borrower’s equity. From the lender’s perspective, the more equity the borrower has (i.e., the lower the LTV), the less likely the borrower is to default. Moreover, the lower the LTV, the more protection the lender has for recovering the amount loaned if the borrower does default and the lender repossesses and sells the property.

Question 169

Foreclosure:

Recourse loan vs Non Recourse loan

Answer 169

In a recourse loan, the lender has a claim against the borrower for the shortfall between the amount of the mortgage balance outstanding and the proceeds received from the sale of the property.
In a non-recourse loan, the lender does not have such a claim, so the lender can look only to the property to recover the outstanding mortgage balance. In the United States, residential mortgages are typically non-recourse loans. Residential mortgages in most European countries are recourse loans.

Question 170

Why is the cash flow for a mortgage pass-through security unknown?

Answer 170

The cash flow is unknown because the prepayment rate over the life of the mortgages in the mortgage pool is unknown and can only be projected on the basis of an assumed prepayment rate.

Question 171

Prepayment risks, contraction risk and extension risk

Answer 171

Contraction risk is the risk that when interest rates decline, the security will have a shorter maturity than was anticipated at the time of purchase because homeowners refinance at now-available lower interest rates. A security becoming shorter in maturity when interest rates decline has two adverse consequences. First, the proceeds received must now be reinvested at lower interest rates. Second, if the bond is prepayable or callable, its price appreciation is not as great as that of an otherwise identical bond that does not have a prepayment or call option.

In contrast, extension risk is the risk that when interest rates rise, fewer prepayments will occur because homeowners are reluctant to give up the benefits of a contractual interest rate that now looks low. As a result, the security becomes longer in maturity than anticipated at the time of purchase. From the investors’ perspective, the value of the security has fallen because interest rates are higher whereas the income they receive (and can potentially reinvest) is typically limited to the interest payment and scheduled principal repayments.

Question 172

In a portfolio management meeting, you hear one of your colleagues make the following statement: “Mortgage pass-through securities are not as complicated as collateralized mortgage obligations, which divide the cash flows into different bond classes. The agency CMOs are far more risky than the pass-throughs.” How would you respond?

Answer 172

The statement is incorrect. There are various types of agency CMOs—such as sequential-pay bond classes, PAC bond classes, and support bond classes. The fact that the cash flows from the collateral are allocated to different bond classes does not make them riskier. Indeed, the purpose of creating different bond classes in a CMO is to provide a risk−return profile that is more suitable to investors that the risk-return profile of the mortgage pass-through securities. For example, a mortgage pass-through security has considerably more variability in average life than does a PAC bond created from that mortgage pass-through security. In contrast, a support bond has greater average-life variability than a mortgage pass-through security has. Therefore, bond classes in a CMO may be more or less risky than a mortgage pass-through security with respect to prepayment risk. A blanket statement about relative riskiness, such as the one made in the meeting, is incorrect.

Question 173

What are the two main ways in which credit card receivable-backed securities differ from auto loan receivable-backed securities?

Answer 173

First, the collateral for credit card receivable-backed securities are non-amortizing loans, whereas the collateral for auto loan-backed securities are loans that fully amortize. Second, for auto loan-backed securities, principal is distributed to the bond classes each month, and as a result, the amount of the outstanding pool balance declines over time. For credit card receivable-backed securities, principal received during the lockout period is used to acquire additional credit card receivables. After the lockout period, principal repayments are used to pay off the outstanding principal.
.

Question 174

PSA public securities assossiation

SMM - single monthly mortality and CPR Conditional prepayment rate

Answer 174

• Market participants measure the prepayment rate using two measures: the single monthly mortality (SMM) rate and its corresponding annualized rate, namely, the conditional prepayment rate (CPR). For MBS, the measure widely used by market participants to assess the sensitivity of the securitized bonds to interest rate movements is the weighted average life (WAL) or simply average life of the MBS instead of duration.
• Market participants use the Public Securities Association (PSA) prepayment benchmark to describe prepayment rates. A PSA assumption greater than 100 PSA means that prepayments are assumed to be faster than the benchmark, whereas a PSA assumption lower than 100 PSA means that prepayments are assumed to be slower than the benchmark.

Question 175

CMO objective

Most common types of CMO

Answer 175

• The creation of a collateralized mortgage obligation (CMO) can help manage prepayment risk by distributing the various forms of prepayment risk among different classes of bondholders. The CMO’s major financial innovation is that the securities created more closely satisfy the asset/liability needs of institutional investors, thereby broadening the appeal of mortgage-backed products.
• The most common types of CMO tranches are sequential-pay tranches, planned amortization class (PAC) tranches, support tranches, and floating-rate tranches.

Question 176

Commercial mortgage-backed securities

Answer 176

(CMBS) are securities backed by a pool of commercial mortgage loans on income-producing property.

CMBS have considerable call protection, which allows CMBS to trade in the market more like corporate bonds than like RMBS. This call protection comes in two forms: at the structure level and at the loan level. The creation of sequential-pay tranches is an example of call protection at the structure level. At the loan level, four mechanisms offer investors call protection: prepayment lockouts, prepayment penalty points, yield maintenance charges, and defeasance.

Question 177

CDO what is?

purpose?

Answer 177

• A collateralized debt obligation (CDO) is a generic term used to describe a security backed by a diversified pool of one or more debt obligations (e.g., corporate and emerging market bonds, leveraged bank loans, ABS, RMBS, CMBS or CDO).
• Like an ABS, a CDO involves the creation of an SPV. But in contrary to an ABS where the funds necessary to pay the bond classes come from a pool of loans that must be serviced, a CDO requires a collateral manager to buy and sell debt obligations for and from the CDO’s portfolio of assets to generate sufficient cash flows to meet the obligations of the CDO bondholders and to generate a fair return for the equity holders.
• The structure of a CDO includes senior, mezzanine, and subordinated/equity bond classes.

Question 178

•In a securitization, a special purpose vehicle (SPV) is responsible for the:
A.issuance of the asset-backed securities.
B.collection of payments from the borrowers.
C.recovery of underlying assets for delinquent loans.

•In a securitization structure, time tranching provides investors with the ability to choose between:
A.extension risk and contraction risk.
B.fully amortizing loans and partially amortizing loans.
C.senior bonds and subordinate bonds.

Answer 178

•A is correct. Time tranching is the process in which a set of bond classes or tranches is created that allow investors a choice in the type of prepayment risk, extension or contraction, that they prefer to bear. Senior and subordinate bond classes are used in credit tranching structures as a form of credit enhancement. Credit tranching structures allow investors to choose the amount of credit risk that they prefer to bear.
B is incorrect because fully and partially amortizing loans are the two types of amortizing loans. Amortization is a loan specification or design and refers to how the principal on a loan is repaid.
C is incorrect because senior and subordinate bond classes are used in credit tranching structures as a means of credit enhancement. Credit tranching structures redistribute the credit risk associated with the underlying collateral and allow investors to choose the amount of credit risk that they prefer to bear.

•B is correct. Bank Nederlandse has a claim against Marolf for 1.5 million EUR, the shortfall between the amount of the mortgage balance outstanding and the proceeds received from the sale of the property. This indicates that the mortgage loan is a recourse loan. The recourse/non-recourse feature indicates the rights of a lender in foreclosure. If Marolf had a non-recourse loan, the bank would have only been entitled to the proceeds from the sale of the underlying property, or 2.5 million EUR.
A is incorrect because a bullet loan is a special type of interest-only mortgage for which there are no scheduled principal payments over the entire term of the loan. Since the unpaid balance is less than the original mortgage loan, it is unlikely that Marolf has an interest only mortgage.
C is incorrect because Bank Nederlandse has a claim against Marolf for the shortfall between the amount of the mortgage balance outstanding and the proceeds received from the sale of the property. A non-recourse loan limits the rights of a lender in a foreclosure to the proceeds from the sale of the underlying property.

Question 179

Fran Martin obtains a non-recourse mortgage loan for $500,000. One year later, when the outstanding balance of the mortgage is $490,000, Martin cannot make his mortgage payments and defaults on the loan. The lender forecloses on the loan and sells the house for $315,000. What amount is the lender entitled to claim from Martin?
A.$0.
B.$175,000.
C.$185,000.

Answer 179

A is correct. Because the loan has a non-recourse feature, the lender can only look to the underlying property to recover the outstanding mortgage balance and has no further claim against the borrower. The lender is simply entitled to foreclose on the home and sell it.
B and C are incorrect because the lender would be entitled to claim the shortfall between the mortgage balance outstanding and the proceeds received from the sale of the property only if the loan was of the recourse (not non-recourse) type.

Question 180

In the context of mortgage-backed securities, a conditional prepayment rate (CPR) of 8% means that approximately 8% of an outstanding mortgage pool balance at the beginning of the year will be prepaid:
A.in the current month.
B.by the end of the year.
C.over the life of the mortgages.

Answer 180

B is correct. CPR is an annualized rate which indicates the percentage of the mortgage balance at the beginning of the year which is expected to be prepaid by the end of the year. The single monthly mortality rate (SMM) is a monthly measure of the percentage of the mortgage balance available to prepay for a pool of mortgages that is projected to prepay in the given month. The prepayment rate over the life of mortgages in the mortgage pool could only be computed at the end of the life of the mortgages.
A is incorrect because the single monthly mortality rate (SMM), not the CPR, is the percentage of the outstanding mortgage balance available to prepay for a pool of mortgages at the beginning of the month that is projected to prepay that month.
C is incorrect because the prepayment rate over the life of the mortgages in a mortgage pool could only be computed at the end of the life of the mortgages and therefore can only be projected based on an assumed prepayment rate.

Question 181

•Credit risk is a factor for commercial mortgage-backed securities because they are backed by mortgage loans that:
A.are non-recourse.
B.have limited call protection.
C.have no prepayment penalty points.

•Which commercial mortgage-backed security (CMBS) characteristic causes CMBS to trade more like a corporate bond than an agency residential mortgage-backed security (RMBS)?
A.Call protection
B.Internal credit enhancement
C.Debt-to-service coverage ratio level

Answer 181

•A is correct. Because commercial mortgage loans are non-recourse loans, the lender can only look to the income-producing property backing the loan for interest and principal repayment. If there is a default, the lender looks to the proceeds from the sale of the property for repayment and has no recourse against the borrower for any unpaid mortgage loan balance. Call protection addresses prepayment risk. Investors have considerable call protection at both the structure and the loan level with CMBS. At the loan level, there are four mechanisms that offer investors call protection: prepayment penalty points, prepayment lockouts, yield maintenance charges, and defeasance.
B is incorrect because call protection addresses prepayment risk. Investors have considerable call protection at both the structure and the loan level with CMBS.
C is incorrect because at the loan level there are four mechanisms that offer investors call protection: prepayment penalty points, prepayment lockouts, yield maintenance and defeasance.

•A is correct. With CMBS, investors have considerable call protection. An investor in a RMBS is exposed to considerable prepayment risk, but with CMBS, call protection is available to the investor at both the structure and the loan level. The call protection results in CMBS trading in the market more like a corporate bond than a RMBS. Both internal credit enhancement and the debt-to-service coverage (DSC) ratio address credit risk, not prepayment risk. Internal credit enhancements are available for CMBS, but are not needed for an agency RMBS which is issued with a guarantee by its respective GSE. The DSC ratio level is used as a key indicator of the potential credit performance of the property underlying a commercial mortgage loan.
B is incorrect because an internal credit enhancement mechanism such as “subordination” is used to achieve desired rating levels for a CMBS. An agency RMBS is guaranteed by the respective GSE and does not require a credit enhancement mechanism to reduce credit risk. Both credit enhancement and government guarantees address credit risk, not prepayment risk.
C is incorrect because the debt-to-service coverage (DSC) ratio level is used as a key indicator of the potential credit performance of the property underlying a commercial mortgage loan. If certain DSC levels are needed, then an internal credit enhancement mechanism is used to achieve a desired rating level. The loan-to-value ratio is used for residential mortgage loans. Both ratios are indicators of credit performance and do not address prepayment risk.

Question 182

An excess spread account incorporated into a securitized structure is designed to limit:
A.credit risk.
B.extension risk.
C.contraction risk.

Answer 182

•A is correct. Because of credit risk, all structures have some form of credit enhancement. An excess spread account is a form of internal credit enhancement which involves the allocation of any amounts into an account resulting from monthly funds remaining after paying out the interest to the bond classes, servicing fees, and administrative fees. The excess spread is a design feature of the structure. Time tranching (not an excess spread account) addresses prepayment risk (extension or contraction) to allow investors a choice in the type of prepayment risk that they prefer to bear.
B and C are incorrect because an excess spread account is a form of internal credit enhancement. Time tranching addresses prepayment risk (extension or contraction) to allow investors a choice in the type of prepayment risk that they prefer to bear.

Question 183

Which of the following best describes the cash flow that owners of credit card receivable-backed securities receive during the lockout period?
A.Only principal payments collected
B.Only finance charges and fees collected
C.No cash flow is received as all cash flow collected is reinvested.

Answer 183

•B is correct. During the lockout period, the cash flow that is paid out to security holders is based only on finance charges collected and fees. After the lockout period, the principal is no longer reinvested but paid to investors.
A and C are incorrect because, during the lockout period, the cash flow paid out to credit card receivable-backed security holders is based only on collected finance charges and fees. After the lockout period, the principal is no longer reinvested but paid to investors.

Question 184

Horizon yield

An investor buys a four-year, 10% annual coupon payment bond priced to yield 5.00%. The investor plans to sell the bond in two years once the second coupon payment is received. Calculate the purchase price for the bond and the horizon yield assuming that the coupon reinvestment rate after the bond purchase and the yield-to-maturity at the time of sale are (1) 3.00%,

Answer 184

Começamos por calcular o PV com ytm 5%, C= 10 T =4 FV =100

Calculamos o FV dos cash flow reinvestidos à taxa de 3% durante 2 anos .

Calculamos o PV daqui a 2 anos e somamos aos cash flow para termos o FV em 2 anos.

PV calculado inicialmente = FV/(1+r)^2 e temos o horizon yield para 2 anos.

Question 185

Mac Duration formula

Answer 185

Quanto maior a duration mais sensível à variação das taxas de juro

SUM ((T* Cupão)/(1+r)^T)/PV da obrigação

Simplificando é o peso relativo de cada pagamento atualizado * o periodo onde é feito

Question 186

Modified Duration

aproxx modified duration alternative way

Answer 186

= MAC Duration / (1+yield for period)

se a ytm for de 10% e os periodos forem anuais yfp =10%
Se ytm for 6% e os periodos forem semestrais yfp =3%

Delta Ytm = 5 bps

((PV-) - (Pv+))/(periodDelta ytmPV0)

PV-= PV0 -Delta ytm
PV+ =PV0+Delta ytm

Question 187

Para medir a sensibilidade à taxa de juro de uma callable bond devemos usar que tipo de duration?

Answer 187

devemos usar effective duration.

Effective duration is essential to the measurement of the interest rate risk of a complex bond, such as a bond that contains an embedded call option. The duration of a callable bond is not the sensitivity of the bond price to a change in the yield-to-worst (i.e., the lowest of the yield-to-maturity, yield-to-first-call, yield-to-second-call, and so forth). The problem is that future cash flows are uncertain because they are contingent on future interest rates. The issuer’s decision to call the bond depends on the ability to refinance the debt at a lower cost of funds. In brief, a callable bond does not have a well-defined internal rate of return (yield-to-maturity). Therefore, yield duration statistics, such as modified and Macaulay durations, do not apply; effective duration is the appropriate duration measure.

Question 188

Is convexity always positive?

Answer 188

Negative convexity, which could be called “concavity,” is an important feature of callable bonds. Putable bonds, on the other hand, always have positive convexity. As a second-order effect, effective convexity indicates the change in the first-order effect (i.e., effective duration) as the benchmark yield curve is changed. In Exhibit 8, as the benchmark yield goes down, the slope of the line tangent to the curve for the non-callable bond steepens, which indicates positive convexity. But the slope of the line tangent to the callable bond flattens as the benchmark yield goes down. Technically, it reaches an inflection point, which is when the effective convexity shifts from positive to negative

Question 189

general relationships among interest rate risk, the Macaulay duration, and the investment horizon.

Answer 189

• When the investment horizon is greater than the Macaulay duration of a bond, coupon reinvestment risk dominates market price risk. The investor’s risk is to lower interest rates.
• When the investment horizon is equal to the Macaulay duration of a bond, coupon reinvestment risk offsets market price risk.
• When the investment horizon is less than the Macaulay duration of the bond, market price risk dominates coupon reinvestment risk. The investor’s risk is to higher interest rates.

The difference between the Macaulay duration of a bond and the investment horizon is called the duration gap.

Question 190

The (flat) price on a fixed-rate corporate bond falls one day from 92.25 to 91.25 per 100 of par value because of poor earnings and an unexpected ratings downgrade of the issuer. The (annual) modified duration for the bond is 7.24. Which of the following is closest to the estimated change in the credit spread on the corporate bond, assuming benchmark yields are unchanged?
A.15 bps
B.100 bps
C.108 bps

Answer 190

Given that the price falls from 92.25 to 91.25, the percentage price decrease is 1.084%.

91.25−92.2592.25=−0.01084

Given an annual modified duration of 7.24, the change in the yield-to-maturity is 14.97 bps.
–0.01084 ≈ –7.24 × ΔYield, ΔYield = 0.001497
Therefore, the answer is A. The change in price reflects a credit spread increase on the bond of about 15 bps.

Question 191

An investor buys a four-year, 10% annual coupon payment bond priced to yield 5.00%. The investor plans to sell the bond in two years once the second coupon payment is received. Calculate the purchase price for the bond and the horizon yield assuming that the coupon reinvestment rate after the bond purchase and the yield-to-maturity at the time of sale are (1) 3.00%, (2) 5.00%, and (3) 7.00%

Answer 191

The purchase price is 117.729753.

(1) Total return: 20.300 + 113.394288 = 133.694288.

r=0.065647

(2)
Total return: 20.500 + 109.297052 = 129.797052.
If interest rates remain 5.00% for reinvested coupons and for the required yield on the bond, the realized rate of return over the two-year investment horizon is equal to the yield-to-maturity of 5.00%.

117.729753=129.797052(1+r)2,r=0.050000

(3)
7.00%: The future value of reinvested coupons is 20.700.
(10 × 1.0700) + 10 = 20.700

The bond is sold at 105.424055.

10(1.0700)1+110(1.0700)2=105.424055

Total return: 20.700 + 105.424055 = 126.124055.

117.729753=126.124055(1+r)2,r=0.035037

Question 192

Aproxx Modified And Aproxx Mac Duration

Answer 192

Aproxx Modified = ((PV-)-(PV+))/(DeltaYieldPv02)

Aprox MAC = aproxx modified *(1+r)

Question 193

Money duration

Mac Duration para um portfolio

Answer 193

Ann Modified Duration*PV full

Para calcular a MAc duration de um portfolio ou fazemos os cash flows atualizados de todo o portfolio ou a média ponderada das Mac duration no portfolio.

Question 194

Se quisermos calcular o impacto de uma variação da interest rate sobre o preço de uma obrigação se tivermos a duration devemos:

Answer 194

multiplicar a duration pela variação dos bps

Question 195

A duration dá-nos a variação do preço sem contar com a convexidade, dá-nos a linha reta, daí que a convexidade deva ser calculada, a sua fórmula é:

Answer 195

((Pv-)+(PV+)-2Pv0 ) / (Deltayield)^2*Pv0

Question 196

Delta PV full

Answer 196

Delta PV full= - annModDurationDelta yield + 0,5Deltayield ^2 *ann Convexity

Question 197

An Italian bank holds a large position in a 7.25% annual coupon payment corporate bond that matures on 4 April 2029. The bond’s yield-to-maturity is 7.44% for settlement on 27 June 2014, stated as an effective annual rate. That settlement date is 83 days into the 360-day year using the 30/360 method of counting days.

1. Calculate the full price of the bond per 100 of par value.
2. Calculate the approximate modified duration and approximate convexity using a 1 bp increase and decrease in the yield-to-maturity.
3. Calculate the estimated convexity-adjusted percentage price change resulting from a 100 bp increase in the yield-to-maturity.
4. Compare the estimated percentage price change with the actual change, assuming the yield-to-maturity jumps to 8.44% on that settlement date.

Answer 197

1. 99.956780
2. aprox modified dur= 8.6907

aprox convexity =107.046

3. The convexity-adjusted percentage price drop resulting from a 100 bp increase in the yield-to-maturity is estimated to be 8.1555%. Modified duration alone estimates the percentage drop to be 8.6907%. The convexity adjustment adds 53.52 bps.
4. The actual percentage change in the bond price is –8.1794%. The convexity-adjusted estimate is –8.1555%, whereas the estimated change using modified duration alone is –8.6907%.

Question 198

Market price risk vs coupon reivestment risk

Answer 198

• Market price risk dominates coupon reinvestment risk when the investor has a short-term horizon (relative to the time-to-maturity on the bond).
• Coupon reinvestment risk dominates market price risk when the investor has a long-term horizon (relative to the time-to-maturity)—for instance, a buy-and-hold investor.

The presence of an embedded call option reduces a bond’s effective duration compared with that of an otherwise comparable non-callable bond. The reduction in the effective duration is greater when interest rates are low and the issuer is more likely to exercise the call option.

The presence of an embedded put option reduces a bond’s effective duration compared with that of an otherwise comparable non-putable bond. The reduction in the effective duration is greater when interest rates are high and the investor is more likely to exercise the put option.

Question 199

Money convexity

Answer 199

Money convexity is convexity times the full price of the bond. Combined with money duration, money convexity estimates the change in the full price of a bond in units of currency given a change in the yield-to-maturity.

• Convexity is a positive attribute for a bond. Other things being equal, a more convex bond appreciates in price more than a less convex bond when yields fall and depreciates less when yields rise.
• Effective convexity is the second-order effect on a bond price given a change in the benchmark yield curve. It is similar to approximate convexity. The difference is that approximate convexity is based on a yield-to-maturity change and effective convexity is based on a benchmark yield curve change.

Question 200

Duration GAP

Answer 200

When the investment horizon is equal to the Macaulay duration of the bond, coupon reinvestment risk offsets price risk. The duration gap is zero.

Question 201

An investor purchases a bond at a price above par value. Two years later, the investor sells the bond. The resulting capital gain or loss is measured by comparing the price at which the bond is sold to the:
A.carrying value.
B.original purchase price.
C.original purchase price value plus the amortized amount of the premium.

Answer 201

A is correct. Capital gains (losses) arise if a bond is sold at a price above (below) its constant-yield price trajectory. A point on the trajectory represents the carrying value of the bond at that time. That is, the capital gain/loss is measured from the bond’s carrying value, the point on the constant-yield price trajectory, and not from the original purchase price. The carrying value is the original purchase price plus the amortized amount of the discount if the bond is purchased at a price below par value. If the bond is purchased at a price above par value, the carrying value is the original purchase price minus (not plus) the amortized amount of the premium. The amortized amount for each year is the change in the price between two points on the trajectory.

Question 202

An investor purchases a nine-year, 7% annual coupon payment bond at a price equal to par value. After the bond is purchased and before the first coupon is received, interest rates increase to 8%. The investor sells the bond after five years. Assume that interest rates remain unchanged at 8% over the five-year holding period.
4.Per 100 of par value, the future value of the reinvested coupon payments at the end of the holding period is closest to:
A.35.00.
B.40.26.
C.41.07.
5.The capital gain/loss per 100 of par value resulting from the sale of the bond at the end of the five-year holding period is closest to a:
A.loss of 8.45.
B.loss of 3.31.
C.gain of 2.75.
6.Assuming that all coupons are reinvested over the holding period, the investor’s five-year horizon yield is closest to:
A.5.66%.
B.6.62%.
C.7.12%.

Answer 202

•C is correct. The future value of reinvested cash flows at 8% after five years is closest to 41.07per 100 of par value.

[7×(1.08)4]+[7×(1.08)3]+[7×(1.08)2]+[7×(1.08)1]+7=41.0662

The 6.07 difference between the sum of the coupon payments over the five-year holding period (35) and the future value of the reinvested coupons (41.07) represents the “interest-on-interest” gain from compounding.
•B is correct. The capital loss is closest to 3.31 per 100 of par value. After five years, the bond has four years remaining until maturity and the sale price of the bond is 96.69, calculated as:

7(1.08)1+7(1.08)2+7(1.08)3+107(1.08)4=96.69

The investor purchased the bond at a price equal to par value (100). Because the bond was purchased at a price equal to its par value, the carrying value is par value. Therefore, the investor experienced a capital loss of 96.69 – 100 = –3.31.
•B is correct. The investor’s five-year horizon yield is closest to 6.62%. After five years, the sale price of the bond is 96.69 (from problem 5) and the future value of reinvested cash flows at 6% is 41.0662 (from problem 4) per 100 of par value. The total return is 137.76 (= 41.07 + 96.69), resulting in a realized five-year horizon yield of 6.62%:

100.00=137.76(1+r)5,r=0.0662

Question 203

An investor buys a three-year bond with a 5% coupon rate paid annually. The bond, with a yield-to-maturity of 3%, is purchased at a price of 105.657223 per 100 of par value. Assuming a 5-basis point change in yield-to-maturity, the bond’s approximate modified duration is closest to:
A.2.78.
B.2.86.
C.5.56.

Answer 203

A is correct. The bond’s approximate modified duration is closest to 2.78.

Question 204

Which of the following statements about duration is correct? A bond’s:
A.effective duration is a measure of yield duration.
B.modified duration is a measure of curve duration.
C.modified duration cannot be larger than its Macaulay duration

Answer 204

C is correct. A bond’s modified duration cannot be larger than its Macaulay duration.

Question 205

An investor buys a 6% annual payment bond with three years to maturity. The bond has a yield-to-maturity of 8% and is currently priced at 94.845806 per 100 of par. The bond’s Macaulay duration is closest to:
A.2.62.
B.2.78.
C.2.83.

Answer 205

C is correct. The bond’s Macaulay duration is closest to 2.83. Macaulay duration (MacDur) is a weighted average of the times to the receipt of cash flow. The weights are the shares of the full price corresponding to each coupon and principal payment.

Question 206

Which of the following statements about duration is correct? A bond’s:
A.effective duration is a measure of yield duration.
B.modified duration is a measure of curve duration.
C.modified duration cannot be larger than its Macaulay duration.

Answer 206

A is correct. The interest rate risk of a fixed-rate bond with an embedded call option is best measured by effective duration. A callable bond’s future cash flows are uncertain because they are contingent on future interest rates. The issuer’s decision to call the bond depends on future interest rates. Therefore, the yield-to-maturity on a callable bond is not well defined. Only effective duration, which takes into consideration the value of the call option, is the appropriate interest rate risk measure. Yield durations like Macaulay and modified durations are not relevant for a callable bond because they assume no changes in cash flows when interest rates change.

Question 207

An investor buys a 6% annual payment bond with three years to maturity. The bond has a yield-to-maturity of 8% and is currently priced at 94.845806 per 100 of par. The bond’s Macaulay duration is closest to:
A.2.62.
B.2.78.
C.2.83.

Answer 207

MacDur = 13.50 −10.67 = 2.83

Question 208

The interest rate risk of a fixed-rate bond with an embedded call option is best measured by:
A.effective duration.
B.modified duration.
C.Macaulay duration.

Answer 208

A is correct. The interest rate risk of a fixed-rate bond with an embedded call option is best measured by effective duration. A callable bond’s future cash flows are uncertain because they are contingent on future interest rates. The issuer’s decision to call the bond depends on future interest rates. Therefore, the yield-to-maturity on a callable bond is not well defined. Only effective duration, which takes into consideration the value of the call option, is the appropriate interest rate risk measure. Yield durations like Macaulay and modified durations are not relevant for a callable bond because they assume no changes in cash flows when interest rates change.

Question 209

Which of the following is most appropriate for measuring a bond’s sensitivity to shaping risk?
A.key rate duration
B.effective duration
C.modified duration

Answer 209

A is correct. Key rate duration is used to measure a bond’s sensitivity to a shift at one or more maturity segments of the yield curve which result in a change to yield curve shape. Modified and effective duration measure a bond’s sensitivity to parallel shifts in the entire curve.

Question 210

Which of the following statements about Macaulay duration is correct?
A.A bond’s coupon rate and Macaulay duration are positively related.
B.A bond’s Macaulay duration is inversely related to its yield-to-maturity.
C.The Macaulay duration of a zero-coupon bond is less than its time-to-maturity.

Answer 210

B is correct. A bond’s yield-to-maturity is inversely related to its Macaulay duration: The higher the yield-to-maturity, the lower its Macaulay duration and the lower the interest rate risk. A higher yield-to-maturity decreases the weighted average of the times to the receipt of cash flow, and thus decreases the Macaulay duration.
A bond’s coupon rate is inversely related to its Macaulay duration: The lower the coupon, the greater the weight of the payment of principal at maturity. This results in a higher Macaulay duration. Zero-coupon bonds do not pay periodic coupon payments; therefore, the Macaulay duration of a zero-coupon bond is its time-to-maturity.

Question 211

A limitation of calculating a bond portfolio’s duration as the weighted average of the yield durations of the individual bonds that compose the portfolio is that it:
A.assumes a parallel shift to the yield curve.
B.is less accurate when the yield curve is less steeply sloped.
C.is not applicable to portfolios that have bonds with embedded options.

Answer 211

A is correct. A limitation of calculating a bond portfolio’s duration as the weighted average of the yield durations of the individual bonds is that this measure implicitly assumes a parallel shift to the yield curve (all rates change by the same amount in the same direction). In reality, interest rate changes frequently result in a steeper or flatter yield curve. This approximation of the “theoretically correct” portfolio duration is more accurate when the yield curve is flatter (less steeply sloped). An advantage of this approach is that it can be used with portfolios that include bonds with embedded options. Bonds with embedded options can be included in the weighted average using the effective durations for these securities.

Question 212

A bond with exactly nine years remaining until maturity offers a 3% coupon rate with annual coupons. The bond, with a yield-to-maturity of 5%, is priced at 85.784357 per 100 of par value. The estimated price value of a basis point for the bond is closest to:
A.0.0086.
B.0.0648.
C.0.1295.

Answer 212

B is correct. The PVBP is closest to 0.0648.

Question 213

A bond is currently trading for 98.722 per 100 of par value. If the bond’s yield-to-maturity (YTM) rises by 10 basis points, the bond’s full price is expected to fall to 98.669. If the bond’s YTM decreases by 10 basis points, the bond’s full price is expected to increase to 98.782. The bond’s approximate convexity is closest to:
A.0.071.
B.70.906.
C.1,144.628.

Answer 213

B is correct. The bond’s approximate convexity is closest to 70.906

Question 214

A bond has an annual modified duration of 7.020 and annual convexity of 65.180. If the bond’s yield-to-maturity decreases by 25 basis points, the expected percentage price change is closest to:
A.1.73%.
B.1.76%.
C.1.78%.

Answer 214

C is correct. The expected percentage price change is closest to 1.78%.

Question 215

Which of the following statements relating to yield volatility is most accurate? If the term structure of yield volatility is downward sloping, then:
A.short-term rates are higher than long-term rates.
B.long-term yields are more stable than short-term yields.
C.short-term bonds will always experience greater price fluctuation than long-term bonds.

Answer 215

B is correct. If the term structure of yield volatility is downward-sloping, then short-term bond yields-to-maturity have greater volatility than for long-term bonds. Therefore, long-term yields are more stable than short-term yields. Higher volatility in short-term rates does not necessarily mean that the level of short-term rates is higher than long-term rates. With a downward-sloping term structure of yield volatility, short-term bonds will not always experience greater price fluctuation than long-term bonds. The estimated percentage change in a bond price depends on the modified duration and convexity as well as on the yield-to-maturity change.

Question 216

The holding period for a bond at which the coupon reinvestment risk offsets the market price risk is best approximated by:
A.duration gap.
B.modified duration.
C.Macaulay duration.

Answer 216

C is correct. When the holder of a bond experiences a one-time parallel shift in the yield curve, the Macaulay duration statistic identifies the number of years necessary to hold the bond so that the losses (or gains) from coupon reinvestment offset the gains (or losses) from market price changes. The duration gap is the difference between the Macaulay duration and the investment horizon. Modified duration approximates the percentage price change of a bond given a change in its yield-to-maturity.

Question 217

When the investor’s investment horizon is less than the Macaulay duration of the bond she owns:
A.the investor is hedged against interest rate risk.
B.reinvestment risk dominates, and the investor is at risk of lower rates.
C.market price risk dominates, and the investor is at risk of higher rates.

Answer 217

C is correct. The duration gap is equal to the bond’s Macaulay duration minus the investment horizon. In this case, the duration gap is positive, and price risk dominates coupon reinvestment risk. The investor risk is to higher rates.
The investor is hedged against interest rate risk if the duration gap is zero; that is, the investor’s investment horizon is equal to the bond’s Macaulay duration. The investor is at risk of lower rates only if the duration gap is negative; that is, the investor’s investment horizon is greater than the bond’s Macaulay duration. In this case, coupon reinvestment risk dominates market price risk.

Question 218

Why should credit analysts be concerned if a company’s stock trades below book value?

A•It means the company is probably going bankrupt.
B•It means the company will probably incur lots of debt to buy back its undervalued stock.
C•It’s a signal that the company’s asset value on its balance sheet may be impaired and have to be written down, suggesting less collateral protection for creditors.

Answer 218

C

Question 219

Thus, issuer liquidity is a key focus in high-yield analysis. Sources of liquidity, from strongest to weakest, are the following:

Answer 219

• Cash on the balance sheet
• Working capital
• Operating cash flow
• Bank credit facilities
• Equity issuance
• Asset sales

Question 220

debt leverage como se calcula?

Net debt leverage?

Answer 220

Debt leverage= Debt/EBITDA

Net debt leverage = (Debt-Cash)/EBITDA

Question 221

Em caso de uma empresa mãe ter dívida e a subsidiária também ter dívida, em que os cash flow do grupo são dependentes das filhas qual é a dívida subordinada em caso de falência a da empresa mãe ou a dívida das filhas?

Answer 221

A dívida subordinada é a dívida das filhas visto que os resultados da mãe dependem dos resultados das filhas.

Also important is that although the debt of an operating subsidiary may be “closer to” and better secured by particular assets of the subsidiary, the credit quality of a parent company might still be superior. The parent company could, while being less directly secured by any particular assets, still benefit from the diversity and availability of all the cash flows in the consolidated system. In short, credit quality is not simply an automatic analysis of debt provisions and liens.

Question 222

Para analisar dívida de um país para além de avaliar a habilidade que esse país tem para pagar também devemos avaliar a sua…

Answer 222

2) its willingness to pay. Willingness to pay is important because, due to the principle of sovereign immunity, investors are generally unable to force a sovereign to pay its debts.

Question 223

Revenue and GO Bonds

Answer 223

Revenue bonds are issued for specific project financing (e.g., financing for a new sewer system, a toll road, bridge, hospital, a sports arena, etc.). Revenue bonds have a higher degree of risk than GO bonds because they are dependent on a single source of revenue. The analysis of these bonds is a combination of an analysis of the project and the finances around the particular project. The project analysis focuses on the need and projected utilization of the project, as well as on the economic base supporting the project. The financial analysis has some similarities to the analysis of a corporate bond in that it is focused on operating results, cash flow, liquidity, capital structure, and the ability to service and repay the debt. A key credit metric for revenue-backed municipal bonds is the debt service coverage ratio (DSCR), which measures how much revenue is available to cover debt payments (principal and interest) after operating expenses. Many revenue bonds have a minimum DSCR covenant; the higher the DSCR, the stronger the creditworthiness.

• General obligation (GO) bonds are backed by the taxing authority of the issuing municipality (e.g., state or city). The credit analysis of GO bonds has some similarities to sovereign analysis—debt burden per capita versus income per capita, tax burden, demographics, and economic diversity. Underfunded and “off-balance-sheet” liabilities, such as pensions for public employees and retirees, are debt-like in nature.
• Revenue-backed bonds support specific projects, such as toll roads, bridges, airports, and other infrastructure. The creditworthiness comes from the revenues generated by usage fees and tolls levied.

Question 224

Which of the following is the best measure of credit risk?
A.The expected loss
B.The severity of loss
C.The probability of default

Answer 224

A is correct. The expected loss captures both of the key components of credit risk: (the product of) the likelihood of default and the loss severity in the event of default. Neither component alone fully reflects the risk.

Question 225

The Acme Company has senior unsecured bonds as well as both first and second lien debt in its capital structure. Which ranks higher with respect to priority of claims: senior unsecured bonds or second lien debt?

Answer 225

Second lien debt ranks higher, by virtue of its secured position.

Question 226

In the event of bankruptcy, claims at the same level of the capital structure are:
A.on an equal footing, regardless of size, maturity, or time outstanding.
B.paid in the order of maturity from shortest to longest, regardless of size or time outstanding.
C.paid on a first-in, first-out (FIFO) basis so that the longest-standing claims are satisfied first, regardless of size or maturity

Answer 226

A is correct. All claims at the same level of the capital structure are pari passu (on an equal footing).

Question 227

•What is the difference between an issuer rating and an issue rating?
A.The issuer rating applies to all of an issuer’s bonds, whereas the issue rating considers a bond’s seniority ranking.
B.The issuer rating is an assessment of an issuer’s overall creditworthiness, whereas the issue rating is always higher than the issuer rating.
C.The issuer rating is an assessment of an issuer’s overall creditworthiness, typically reflected as the senior unsecured rating, whereas the issue rating considers a bond’s seniority ranking (e.g., secured or subordinated).

•Based on the practice of notching by the rating agencies, a subordinated bond from a company with an issuer rating of BB would likely carry what rating?
A.B+
B.BB
C.BBB–

Answer 227

Solution to 3:

C is correct.

Solution to 4:

A is correct. The subordinated bond would have its rating notched lower than the company’s BB rating, probably by two notches, reflecting the higher weight given to loss severity for below-investment-grade credits.

Question 228

Amalgamated Corp. and Widget Corp. each have bonds outstanding with similar coupons and maturity dates. Both bonds are rated B2, B–, and B by Moody’s, S&P, and Fitch, respectively. The bonds, however, trade at very different prices—the Amalgamated bond trades at €89, whereas the Widget bond trades at €62. What is the most likely explanation of the price (and yield) difference?
A.Widget’s credit ratings are lagging the market’s assessment of the company’s credit deterioration.
B.The bonds have similar risks of default (as reflected in the ratings), but the market believes the Amalgamated bond has a higher expected loss in the event of default.
C.The bonds have similar risks of default (as reflected in the ratings), but the market believes the Widget bond has a higher expected recovery rate in the event of default.

Answer 228

A is correct. Widget’s credit ratings are probably lagging behind the market’s assessment of its deteriorating creditworthiness. Answers B and C both state the situation backwards. If the market believed that the Amalgamated bond had a higher expected loss given default, then that bond would be trading at a lower, not a higher, price. Similarly, if the market believed that the Widget bond had a higher expected recovery rate in the event of default, then that bond would be trading at a higher, not a lower, price.

Question 229

Riscos e limitações credit ratings

Answer 229

1- credit ratings podem ser muito dinâmicos
2- as empresas de rating enganam-se
3- risco sistémico é dificil de quantificar
4-os rating são lagging indicator, o preço das obrigações reflete mais rápido a qualidade creditícia

Question 230

os 4 C’s na análise de crédito

Answer 230

1- capacity ( capacidade de pagar em tempo útil)
2- collateral
3-covenants
4-character (qualidade da gestão)

Question 231

yield corporate components

yield spread

Answer 231

yield corporate components - rf+ E(inflation)+yield spread

yield spread - liquidity premium + credit spread

Question 232

•In the event of default, debentures’ claims will most likely rank:
A.above that of secured debt holders.
B.below that of secured debt holders.
C.the same as that of secured debt holders.

Answer 232

•B is correct. Secured debt holders have a direct claim on certain assets and their associated cash flows whereas unsecured debt holders only have a general claim on the issuer’s assets and cash flow.

Question 233

•In the event of default, the recovery rate of which of the following bonds would most likely be the highest?
A.First mortgage debt
B.Senior unsecured debt
C.Junior subordinate debt

Answer 233

•A is correct. First mortgage debt is the highest ranked debt in terms of priority of claims and is considered secured debt. First mortgage debt will also have the expected highest recovery rate. First mortgage debt refers to the pledge of specific property. Neither senior unsecured nor junior subordinate debt has any claims on specific assets.

Question 234

•During bankruptcy proceedings of a firm, the priority of claims was not strictly adhered to. Which of the following is the least likely explanation for this outcome?
A.Senior creditors compromised.
B.The value of secured assets was less than the amount of the claims.
C.The judge’s order resulted in actual claims not adhering to strict priority of claims.

Answer 234

•B is correct. Whether or not secured assets are sufficient for the claims, this would not influence priority of claims. The difference between pledge assets and the claim becomes senior unsecured debt and still adheres to the guidelines of priority of claims.

Question 235

•Although rating agencies assess the creditworthiness of debt issuers and issues, the least likely reason that a fixed income analyst should conduct an independent analysis of credit risk is because rating agencies:
A.may at times mis-rate issues.
B.often lag the market in pricing credit risk.
C.cannot foresee future debt-financed acquisitions.

Answer 235

•C is correct. Neither an analyst nor ratings agencies can anticipate unexpected events.

Question 236

•Jaco Meyer, a credit analyst, is analyzing the human capital of a company. Such an analysis will most likely give Meyer insight into the:
A.quality of the company’s management.
B.strength of the company’s balance sheet.
C.power of the company’s customers.

Answer 236

•B is correct. An analysis of the human capital of a company is the purpose of assessing the strength of its balance sheets or, stated differently, the value and quality of assets supporting the issuer’s indebtedness (i.e., collateral).

Question 237

•If goodwill makes up a large percentage of a company’s total assets, this most likely indicates that:
A.the company has low free cash flow before dividends.
B.there is a low likelihood that the market price of the company’s common stock is below book value.
C.a large percentage of the company’s assets are of low quality.

Answer 237

•C is correct. Goodwill is viewed as a lower quality asset compared with tangible assets that can be sold and more easily converted into cash.

Question 238

In order to determine the capacity of a company, it would be most appropriate to analyze the:
A.company’s strategy.
B.growth prospects of the industry.
C.aggressiveness of the company’s accounting policies.

Answer 238

B is correct. The growth prospects of the industry provide the analyst insight regarding the capacity of the company