Fixed Income II

Question 1

Duration - impact of call options

Answer 1

Less sensitive - limits upside price movement

Question 2

Duration - impact of put options

Answer 2

Less sensitive - limits downside price movement

Question 3

Duration Formula

Answer 3

Percentage change in price / percent change in yield

Question 4

T-bills

Answer 4

(1) maturity < 1 year

(2) 4-week, 3-month, and 6-months

Question 5

Treasury notes

Answer 5

(1) Semi annual payments
(2) 2, 3, 5 and 10 year maturities
(3) Quoted in 32nds, e.g. 100.5 = 100 & 5/32

Question 6

STRIP prepayment affect

Answer 6

(1) Interest only receives less

(2) Principal only gets same amount faster

Question 7

Muni tax treatment

Answer 7

Interest exempt from federal tax
same state = state tax exempt
Capital gains not exempt

Question 8

Double-baralled munis

Answer 8

Backed by taxes and revenue sources

Question 9

Appropriation-backed (moral bonds)

Answer 9

State acts as back-up, though not legally required to do so

Question 10

Revenue bonds

Answer 10

Supported by revenues generated by projects. Do not require voter approval. More risky.

Question 11

Unsecured debt (debentures)

Answer 11

Not backed by any pledged asset

Question 12

Commercial paper

Answer 12

< 270 days, exempt from SEC regulations

Issued at a discount like t-bills

Question 13

Bankers acceptance

Answer 13

Letter of credit guaranteeing payment between two banks, usually when shipping goods.

Question 14

Special purpose vehicle

Answer 14

(1) Separate legal entity
(2) Shields assets from corporations general creditors
(3) Used for ABS
(4) allows for higher rating

Question 15

Collateralized Debt Obligation (CDO)

Answer 15

Debt instrument with underlying pool of other debt.

Tranches are created based on seniority and claims to cash flow.

Question 16

Pure expectations theory

Answer 16

(1) Yield curve represents expectations of short term rates in the future
(2) If short-term rates are expected to rise, future rates are higher than current rates

Question 17

Liquidity preference theory

Answer 17

(1) In addition to pure expectations, investors require a risk premium for holing longer dated bonds
(2) yield curve can still slope down if expectations exceed liquidity premium

Question 18

Market segmentation theory

Answer 18

(1) supply and demand dictate rates over different time periods

Question 19

Preferred habits theory

Answer 19

(1) Weaker form of market segmentation theory

(2) Investors can be induced to move from preferred ranges, if rates are high enough.

Question 20

Yield to maturity

Answer 20

Single discount rate that makes present value of a bod’s future cash flows equal to market price.

Question 21

Spot rate

Answer 21

Discount rate for individual future payments.

Question 22

Absolute yield spread

Answer 22

Yield on higher yield bond - yield on lower yield bond

Question 23

Relative yield spread

Answer 23

Absolute yield spread / benchmark bond yield

Question 24

Yield ratio

Answer 24

Subject bond yield / benchmark bond yield

Question 25

After tax yield formula

Answer 25

taxable yield * (1-marginal tax rate)

Question 26

Taxable equivalent yield

Answer 26

(tax free yield) / (1-marginal tax rate)