Chapter 7

Question 1

What are the two forms of capital securities?

Answer 1

1. Capital trust securities- issued by banks/insurance companies
2. Preferred securities- issued by utility, resource, and industrial companies with very long maturity dates and pay interest rather than dividends

Question 2

How does the coupon work on the RBR?

Answer 2

The real coupon rate is applied to a principal balance that has been adjusted for the cumulative level of inflation since the date the bond was issued
Payment= real coupon rate/2 x (principal + inflation compensation)

Question 3

How to calculate inflation compensation

Answer 3

=(principal x current CPI/base CPI)-principal

Question 4

To which day of the month does the Stats Canada CPI reading apply?

Answer 4

the CPI reading for any given monthly is assumed to be the CPI on the first calendar day of the month

Question 5

How does one calculate the CPI reading on any day of the month?

Answer 5

-via linear interpolation between the CPI from the current month and one for the following month

Question 6

CPI is a ________ indicator- in any given month, its reading is not released until the __________. The CPI for Gov RRBs is based on the CPI reading from __________.

Answer 6

• lagging
• third week of the following month
• the third preceding calendar month

Question 7

How to calculate CPI on any date

Answer 7

Current CPI= CPIm + (t+1/D x (CPIm+1 - / CPIm)

Question 8

Describe issuer extendible notes

Answer 8

• obligations with embedded call options that an issuer owns that at certain times allow it to pay off the bond or extend the maturity
• usually higher yield

Question 9

What are 3 basic price characteristics of bonds

Answer 9

1. for a given change in yield, the percentage change in bond prices are greater for longer maturities
2. for larger changes in yield, a given downward movement in yield results in a bigger percentage change in price than the same move upward in yield
3. all else being equal, the higher the coupon, the smaller the percentage price change will be for a given change in yield

Question 10

Describe Maccaulay duration

Answer 10

• the weighted average term to maturity of the present value of a bond’s interest and principal payments
• thought of as the average life of the bond measured in years

Question 11

Describe modified duration

Answer 11

-a measure of the approximate percentage price change for every 100 bps change in yield
ModDur= MacDur/(1+(y/k))

Question 12

Duration is a reflection of a bond’s particular term to maturity, coupon, and yield, which are all related in the following ways:

Answer 12

1. A bond with no coupon payments will have a MacDur equal to its term to maturity
2. The ModDur will always be less than the term to maturity
3. All else being equal, the lower the coupon rate, the greater the ModDur
4. All else being equal, the longer the term to maturity the greater the ModDur
5. All else being equal, the lower the yield, the greater the ModDur

Question 13

What is the formula for Approximate Percentage Price Change?

Answer 13

= -(ModDur) x Change in yield x 100

Question 14

Describe convexity

Answer 14

• used to improve the estimate of duration
• an adjustment that is added to the duration
• a measure of how much a bond’s price/yield curve deviates from the linear approximation of that curve

Question 15

What is the approximate price change due to convexity formula

Answer 15

=convexity/2 x (change in yield)^2 x 100

Question 16

What are two characteristics of convexity?

Answer 16

• the change in value resulting from the convexity term is always positive
• over a series of bonds with the same coupon rate and YTM, convexity increases with time to maturity