Fixed Income Flashcards
Which of the following statements concerning convexity are accurate or true?
I. A common use for convexity is to estimate the percentage price changes in bonds for assumed changes in time.
II. Convexity measures the curvature of the price/yield relationship.
III. Given its limitations, modified convexity is not ideal for analyzing securities with embedded options.
IV. Convexity is often described as the first-order approximation of price changes while duration represents a second derivative of price change.
II & III
A common use for convexity is to estimate the percentage price changes in bonds for assumed changes in yield.
Convexity measures the curvature of the price/yield relationship.
Given its limitations, modified convexity is not ideal for analyzing securities with embedded options.
Duration is often described as the first-order approximation of price changes while convexity represents a second derivative of price change.
A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 10%. The intrinsic value of the bond today will be _________ if the coupon rate is 7%.
FV = 1000, PMT = 70, n = 5, i = 10,
PV = 886.28.
The duration of a perpetuity with a yield of 8% is:
1.08/0.08 = 13.50 years
You purchased an annual interest coupon bond one year ago with 6 years remaining to maturity at the time of purchase. The coupon interest rate is 10% and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond’s yield to maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been _________.
FV = 1000, PMT = 100, n = 6, i = 8, PV = 1092.46;
FV = 1000, PMT = 100, n = 5, i = 7, PV = 1123.01;
HPR = (1123.01 - 1092.46 + 100)/1092.46 =
11.95%.
A convertible bond has a par value of $1,000 and a current market value of $950. The current price of the issuing firm’s stock is $22 and the conversion ratio is 40 shares. The bond’s conversion premium is _________.
$950 - $880 = $70
Bonds with greater curvature _________ more in price when yields fall than they _______ when yields rise.
gain / lose
This is based on the concept of convexity. Thus, the impact on price is greater when rates fall vs. when they rise.
The basic purpose of immunization is to…
offset price and reinvestment risk.
produce a zero net interest-rate risk.
eliminate default risk and produce a zero net interest-rate risk.
produce a zero net interest-rate risk and offset price and reinvestment risk.
produce a zero net interest-rate risk and offset price and reinvestment risk.
When a portfolio is immunized, price risk and reinvestment risk exactly offset each other resulting in zero net interest-rate risk.
When a bond indenture includes a sinking fund provision…
firms must establish a cash fund for future bond redemption and bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed.
firms must establish a cash fund for future bond redemption.
bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed.
bondholders may lose because their bonds can be repurchased by the corporation at below-market prices.
bondholders may lose because their bonds can be repurchased by the corporation at below-market prices.
A sinking fund provision requires the firm to redeem bonds over several years, either by open market purchase or at a special call price from bondholders. This can result in repurchase in advance of scheduled maturity at below-market prices.
A bond will sell at a discount when _____________________________.
the coupon rate is greater than yield to maturity.
the coupon rate is less than the current yield and the current yield is greater than the yield to maturity.
the coupon rate is greater than the current yield and the current yield is greater than yield to maturity.
the coupon rate is less than the current yield and the current yield is less than yield to maturity.
the coupon rate is less than the current yield and the current yield is less than yield to maturity.
In order for the investor to earn more than the current yield, the bond must be selling for a discount. Yield to maturity will be greater than current yield as investor will have purchased the bond at discount and will be receiving the coupon payments over the life of the bond.
Which of the following statements regarding the “indexing of bond portfolios” is not accurate?
Many bonds are thinly traded so it is difficult to purchase them at a fair market price.
The composition of bond indexes is constantly changing.
Bond indexes typically use the same weighting methodologies and offer the same pricing structures as equity indexes.
The number of bonds included in the major indexes is so large that it would be difficult to purchase them in the proper proportions.
Bond indexes typically use the same weighting methodologies and offer the same pricing structures as equity indexes.
Bond indexes do not typically use the same weighting methodologies due to the challenges listed above and the pricing structures are often different from equity indexes as well.
Par value bond XYZ has a modified duration of 6. Which one of the following statements regarding the bond is true?
If the market yield increases by 1%, the bond’s price will decrease by $50.
If the market yield increases by 1%, the bond’s price will increase by $50.
If the market yield increases by 1%, the bond’s price will decrease by $60.
If the market yield increases by 1%, the bond’s price will increase by $60.
If the market yield increases by 1%, the bond’s price will decrease by $60.
DP/P = -D*Dy; -$60 = -6(0.01) X $1,000.
Which of the following are true about the interest-rate sensitivity of bonds?
I. Bond prices and yields are inversely related.
II. Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.
III. Interest-rate risk is directly related to the bond’s coupon rate.
IV. The sensitivity of a bond’s price to a change in its yield to maturity is inversely related to the yield to maturity at which the bond is currently selling.
I, II, and IV only
Number III is incorrect because interest-rate risk is inversely related to the bond’s coupon rate.
The yield to maturity on a bond is __________________________________.
below the coupon rate when the bond sells at a discount, and equal to the coupon rate when the bond sells at a premium
based on the assumption that any payments received are reinvested at the coupon rate
the discount rate that will set the present value of the payments equal to the bond price and based on the assumption that any payments received are reinvested at the coupon rate
the discount rate that will set the present value of the payments equal to the bond pri
Answer: the discount rate that will set the present value of the payments equal to the bond price
The yield to maturity on a bond is the discount rate that will set the present value of the payments equal to the bond price.
What is the duration of a par value 12% coupon bond experiencing a price change of $23 when the market yield changes by 50 basis points?
The bond with a duration of 5.15 years
dP/P = -D x dY / (1+Y). -0.023 = -D x .005 / 1.12. D = 5.15
An 8%, 30-year corporate bond was recently being priced to yield 10%. The Macaulay duration for the bond is 10.20 years. Given this information, the bond’s modified duration would be _____________.
D* = D/(1 + y); D* = 10.2/(1.1) = 9.27.
