Chapter 9 - Analysis of Debt Securities I - Valuation, Term Structure and Pricing - 5.7% Flashcards
What kind of shift can cause the yield curve to flatten? A. Twist. B. Hump. C. Parallel up. D. Parallel down.
A is correct.
The yield curve is not static. Over time, the shape changes to reflect the market level of interest rates. A twist occurs when yields toward one end of the yield curve move up or down by more than yields at the other end, or if yields at one end move up or down while yields at the other end move in the opposite direction. Twists cause the yield curve to steepen or flatten.
Which of the following statements about benchmark Government of Canada securities is false?
A. They are issued at regularly scheduled auctions.
B. They eventually become on-the-run bonds for their benchmark maturity.
C. Their yields determine the shape of the Government of Canada yield curve.
D. They are less liquid than non-benchmark Government of Canada securities.
D is correct.
The Canada yield curve depicts the yield to maturity on the Government of Canada’s seven benchmark securities: 3-month, 6-month, and 1-year T-bills; and 2-year, 5-year, 10-year, and 30-year bonds. These securities are issued at regularly scheduled auctions. When a new benchmark security is issued, it eventually becomes the on-the-run issue for that benchmark maturity. Generally, the benchmark securities are the most liquid in each maturity range.
In which of the following accrued interest calculations is the coupon rate of a semi-annual pay bond divided by 2? A. Actual/actual. B. Actual/365. C. Actual/360. D. 30/360.
A is correct.
Only in the actual/actual calculation is the coupon rate of a semi-annual pay bond divided by 2. In all other calculations, the annual coupon rate is used.
What is the assumed yield on a callable bond based on? A. The current yield. B. The yield to best. C. The yield to worst. D. The yield to maturity.
C is correct.
For callable bonds, yields are calculated to all call dates and to the maturity date. The lowest yield from this set of yields –the yield to worst – is taken as the assumed yield.
How is the liquidity risk of a bond normally determined?
A. By the yield spread relative to its benchmark bond multiplied by a factor of 2.
B. By the benchmark bond’s bid-ask yield spread.
C. By comparing the bond’s yield spread relative to its benchmark bond to another bond’s yield spread relative to the same benchmark bond.
D. By comparing the bond’s bid-ask yield spread to the benchmark bond’s bid-ask yield spread.
D is correct.
Liquidity risk is measured by comparing the bond’s bid-ask yield spread to the benchmark bond’s bid-ask yield spread. The less liquid the bond, the greater its bid-ask yield spread relative to its benchmark bond.
Which statement regarding the yield curve is true?
A. The yield curve is not static.
B. A flat yield curve is called a normal yield curve.
C. Twists occur when the yield at a specific maturity moves up or down independently.
D. The yield curve is a graphical representation of interest rates and yield to maturity.
A is correct.
Yield curves graphically represent the relationship between bond yields and term to maturity. An upward-sloping yield curve is also called a normal yield curve. The yield curve is not static. Over time, the shape changes to reflect the market level of interest rates. Twists occur when yields toward one end of the yield curve move up or down by more than yields at the other end, or when yields at one end move up or down while yields at the other end move in the opposite direction.
What economic variable increases at the trough phase of the economic cycle? A. Inflation. B. Interest rates. C. Demand for credit. D. Unemployment.
D is correct.
During the trough phase, demand for goods and services is low, profits decline further, unemployment rises, and the need for investment is reduced. With further reductions in price pressure, inflation declines and the demand for credit remains low, resulting in further declines in interest rates.
All else being equal, which classes of bonds have the correct spread relationship?
A. AAA-rated bonds have higher credit spreads than A-rated bonds.
B. Less liquid bonds have higher spreads than equivalent liquid bonds.
C. Convertible bonds have higher spreads than equivalent non-convertible bonds.
D. Non-callable bonds have higher spreads than equivalent callable bonds.
B is correct.
Spreads compensate investors for taking on risks above and beyond the risks associated with Government of Canada bonds. Non-callable bonds with a higher credit rating trade at lower credit spreads than non-callable bonds with lower credit ratings. Callable bonds are offered with a spread that is greater than the spread of an otherwise equivalent non-callable bond. Since convertible bonds benefit the investor, the spread will be less than an equivalent option-free bond. A lower level of liquidity translates into a wider bid-ask spread.
After several quarters of strong GDP growth and relatively modest inflation, commodity prices have finally broken out of a 5-year slump and look set to move substantially higher. What impact would this likely have on the bond market and why?
A. Interest rates would fall and prices would rise in anticipation of weaker GDP growth.
B. Interest rates would rise and prices would fall in anticipation of weaker GDP growth.
C. Interest rates would fall and prices would rise in anticipation of higher inflation.
D. Interest rates would rise and prices would fall in anticipation of higher inflation.
D is correct.
Strong commodity markets are generally a negative influence on bond markets. First, rising commodity prices reflect strong growth. However – and possibly more importantly – they directly indicate rising prices, and inflation negatively affects bond markets.Strong commodity markets are generally a negative influence on bond markets. First, rising commodity prices reflect strong growth. However – and possibly more importantly – they directly indicate rising prices, and inflation negatively affects bond markets.
The 10-year, 5.25% Government of Canada bond is trading at a price of $98.70 with a yield of 5.42%. A 10-year, 6.50% corporate bond is trading at a price of $101.99 with a yield of 6.23%. What is the spread on the corporate bond relative to the Government of Canada bond? A. 27 basis points. B. 81 basis points. C. 125 basis points. D. 329 basis points.
B is correct.
A spread is the difference between the yields on two debt securities, normally expressed in basis points. In this case, the spread = 6.23% – 5.42% = 0.81% = 81 basis points.
