Chapter 21

Question 1

Measures of Recent Economic Activity

Answer 1

GDP, employment, housing, retail sales, industrial surveys, trade balance

Question 2

Measures of inflation

Answer 2

CPI, producer price index, GDP price deflator

Question 3

Measures of future economic activity

Answer 3

index of leading indicators, consumer confidence

Question 4

Monetary Policy

Answer 4

he control of the quantity of money available in an economy and the channels by which new money is supplied.

Question 5

Interest Rate Policy

Answer 5

Sets the official short term interest rate (overnight rate) which is the interest rate at which financial institutions can borrow and lend one-day funds among themselves

Question 6

Open Market Operations

Answer 6

Involve the purchase or sale of T-bills or government bonds by the BOC which influences the overall money supply (BOC sells securities, money supply decreases; BOC buys securities, money supply increases)

Question 7

Fiscal Policy

Answer 7

Fiscal policy guides the spending a government undertakes to provide goods and services and determines the way in which the government finances these expenditures

Question 8

How is government spending financed?

Answer 8

Taxation and borrowing (issuing t-bill/bonds)

Question 9

Quality Spread Theory

Answer 9

This theory is based on the view that credit spreads are affected by the economic cycle. During an economic recovery, the perception of the quality and safety of non-Government of Canada issues improves. As more money moves into non-Government of Canada issues, the price relative to Canada bonds rises and spreads begin to tighten

Question 10

Interest Rate Volatility Theory

Answer 10

According to this theory, in times of high interest rate volatility, yield spreads on callable bonds widen, and yield spreads on putable bonds narrow

Question 11

Which bonds are affected most by change in interest rates?

Answer 11

long term + lower coupon

Question 12

Duration

Answer 12

a way of measuring how much bond prices are likely to change if and when interest rates move

Question 13

Macaulay Duration

Answer 13

tells the weighted average time that a bond needs to be held so that the total present value of the cash flows received is equal to the current market price paid for the bond.

Question 14

Modified Duration

Answer 14

• a measure of the approximate percentage price change for a 100 basis point change in yield

= Macaulay duration/ (1 + (y/k))
where y = yield, and k = # coupon payments per year

Question 15

Portfolio Modified Duration

Answer 15

The modified duration of a portfolio of bonds is a weighted average of the modified durations of the individual bonds

Question 16

Convexity

Answer 16

A measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes

Question 17

Debt Security Active Strategy

Answer 17

investor forms expectations and shifts assets around to take full advantage of those expectations

Question 18

Debt Security Passive Strategy

Answer 18

investor’s portfolio is designed to approximate a market index or to reduce the requirement to make decisions based on expectations

Question 19

Debt Security Dedicated Strategy

Answer 19

designed to meet specific targets and goals

Question 20

Types of Active Debt Security Stategies

Answer 20

1. interest rate strategy
2. yield curve strategies
3. intermarket spread strategies
4. intramarket spread strategies

Question 21

Interest Rate Strategy

Answer 21

Active investors can attempt to exploit differences between their own interest rate forecast and the forecast embedded in market interest rates

Question 22

Yield Curve Strategies

Answer 22

are designed by positioning bonds along the maturity spectrum to take advantage of expected changes in the shape of the curve

Question 23

Bullet Portfolio

Answer 23

portfolio is built with one or more bonds with roughly equal durations

Question 24

Barbell portfolio

Answer 24

portfolio portfolio is built with one or more bonds with short durations combined with one or more bonds with long durations, the average duration equals that of the bullet portfolio

Question 25

Intermarket Spread Strategies

Answer 25

designed to capitalize on the difference in yield spreads and expected changes in yield spreads between different sectors of the bond market

Question 26

Intramarket Spread Strategies

Answer 26

• Involve swapping bonds that are largely similar
• Reason for swap could be based on mispriced securities or relative value differences, or swapping securities for a higher yield

Question 27

Passive Strategies

Answer 27

1. indexation

2. laddering

Question 28

Stratified sampling approach

Answer 28

Takes a market index and divides it into parts called cells, each cell represents a different portfolio characteristic, such as duration, coupon, maturity, sector, credit rating, or call features

Question 29

Optimization

Answer 29

Builds on the stratified sampling approach by using mathematical programming to optimize the portfolio based on the stated return objectives and constraints

Question 30

The Macaulay duration of a zero-coupon bond (including strip bonds) is _______ to the bond’s term to maturity (in years)

Answer 30

equal

Question 31

The Macaulay duration of a coupon bond is always _____ than the bond’s term to maturity. All else being equal, the _____ the coupon, the longer the Macaulay duration, and the _____ the term to maturity, the longer the Macaulay duration

Answer 31

less
smaller
longer

Question 32

The real value of Macaulay duration is that it can be used to:

Answer 32

calculate modified durations, which is a much more useful measure of bond price volatility

Question 33

All else being equal, the longer the term to maturity, the ________ the modified duration

Answer 33

greater

Question 34

All else being equal, the lower the coupon rate, the _______ the modified duration

Answer 34

greater

Question 35

All else being equal, the lower the yield, the _______the modified duration

Answer 35

greater

Question 36

Modified duration is always ______ than the term to maturity

Answer 36

less