Unit 13 (5)

Question 1

What is a bond priced at 102 1/4 equal to?

Answer 1

$1022.50

Question 2

What is the discount rate?

Answer 2

The discount rate is a way of saying the current interest rate

Question 3

When is the best time to buy long term bonds?

Answer 3

When interest rates have peaked. In addition to a high return, as rates fall the bonds value will increase

Question 4

Why does a higher coupon mean a shorter duration?

Answer 4

The higher the interest payments, the shorter the time it will take the repay the principal. If the maturities are about the same, the bond with the higher coupon will have a shorter duration

Question 5

What is discounted cash flow as applied to a bonds price?

Answer 5

The sum of the present value of the par value repaid at maturity plus the present value of coupon payments

Question 6

What is the duration of a zero?

Answer 6

A zero’s duration is equal to its time to maturity because it makes no interest payments

Question 7

What happens to duration if the coupon on a bond increases?

Answer 7

Duration will decrease

Question 8

What are the 4 things you need to know for the Yield to Call calculation?

Answer 8

1. Amount of interest payments to be received
2. Length of time to the call
3. Current price
4. Call price

Question 9

What is an investment grade bond rated?

Answer 9

AAA to BBB

Lower rated bonds are considered high yield and are often called junk bonds

Question 10

Duration measures

Answer 10

The sensitivity of a debt security to changes in interest rates

Question 11

A stock with a longer duration the greater the

Answer 11

Market price movement and vice versa

Question 12

The higher the coupon rate will have a what duration

Answer 12

A shorter duration. The higher the coupon the shorter the duration. The lower the coupon the longer the duration

Question 13

If 2 bonds have roughly the same maturity date, which one will have the shorter duration?

Answer 13

The one with the higher coupon

Question 14

For coupon bonds, the duration is always less than?

Answer 14

The bonds maturity. For coupon bonds the duration will always be less than the bonds maturity.

Question 15

The longer a bonds duration, the more price movement it will have to a 1% move in interest rates

Answer 15

The shorter duration will have a smaller move in relation to a 1% change in interest rates

Question 16

If you were managing a portfolio of bonds and expected rates to decline (prices rise), what would you do?

Answer 16

Lengthen the average duration of the portfolio. If you thought rates were going to rise (prices go down) you would shorten the duration.

Question 17

Which is more useful in determining the price volatility of a bond to a significant change in interest rates?

Answer 17

Convexity is more useful.

Question 18

Duration is linear while convexity

Answer 18

Follows a curve

Question 19

Convexity is

Answer 19

The measurement of the curve that results when plotting a bonds price movements in response to changes in interest rates

Question 20

To compute the future value of the cash flow from a bond, you need to know

Answer 20

1. Principal amount
2. Coupon rate
3. Number of interest payments

Question 21

The higher the discounted cash flow the

Answer 21

The more valuable the investment

Question 22

You are trying to decide between bonds with the same rating and a coupon of 6%. Using Discounted Cash Flow, which bond has the highest market value?

1. 5yr maturity and discount rate is 4%
2. 5yr maturity and discount rate is 8%
3. 10yr maturity and discount rate is 4%
4. 10yr maturity and discount rate is 8%

Answer 22

10yr maturity and discount rate is 4%. Remember the discount rate is another way of saying the current interest rate. If the discount rate is higher than the coupon, the present value will be below par. The longer the time to maturity, the greater impact on the price so the 10yr bond with a coupon of 6% when the discount rate is 4% will have a bigger price mvmt than a 5yr bond.

Question 23

Discounted cash flow

Answer 23

Uses the present value of future cash flows, based on a specified discount (interest) rate to evaluate the price an investment should be selling for in the market.

Question 24

An analyst would use the discounted cash flow method in an attempt to find

1. The fair value of a security
2. The current market price of a security
3. The current rate of return for a security
4. The cash flow from operations

Answer 24

The fair value of a security. Discounted cash flow is uses the present value of future cash flows, based on a specific discount rate to evaluate the price that a security should be selling for in the market

Question 25

When doing cash flow analysis on a mortgage backed passed through security, you would want to know what?

Answer 25

The average maturities

Question 26

A bond quoted at 90 1/4 costs?

Answer 26

$902.50 | Remember in bond pricing 1/8 is 1/8 of $10 or $1.25

Question 27

A bond quoted at 101 3/4 costs?

Answer 27

$1,017.50 | 101 = 1,010 plus $7.50 = $1,017.50

Question 28

Treasury Inflation Protection Securities TIPS

Answer 28

Issued with a fixed interest rate but the principal amount is adjusted semi-annually by an amount equal to the change in the CPI. Issued with maturities of 5, 10, 30 year maturities

Question 29

Interest payments from and increases in principal of TIPS are taxed how?

Answer 29

Subject to federal tax. Exempt at the state and local level

Question 30

TIPS interest payments and increases in principal are exempt from what level of taxation?

Answer 30

State and local

Question 31

You have a TIPS bond with a 3% coupon and inflation is 4% for 2 years here’s what happens

Answer 31

Each six months you will receive 1.5% of the principal value as adjusted for the inflation rate. If the inflation rate is 4% that is 2% each 6 months. So, 2% of 1000 is 20, so the first payment will be 1.5% of $1,020 or $15.30. The next payment will be 1.5% of $1,040.40 etc.

Question 32

A customer wishes to buy a security providing periodic interest payments, safety of principal, and protection from purchasing power risk. What do they buy?

Answer 32

TIPS. Tips offers inflation protection and safety of principal because they are back by the US gov.

Question 33

A client has a TIPS with a coupon rate of 4.5%. The inflation rate has been 7% for the last year. What is the inflation adjusted return? 1. -2.4% 2. 4.5% 3. 7% 4. 11.5%

Answer 33

4.5%. Remember TIPS adjust the principal value every six months to account for the inflation rate, therefor the real rate of return will always be the coupon

Question 34

You buy 10M 6.6s of 10 at 67. What is the annual interest and what does 10M stand for?

Answer 34

10M stands for “10,000 worth of” M is the Roman numeral for 1,000. the coupon is 6.6 so he gets 6.6 percent of 10,000 which is $660

Question 35

If you’re given a question about computing yield to call, make sure to check the amount of payments stated

Answer 35

A bond maturing in 10 years would have 20 payments, they may give you a different number

Question 36

Many fixed income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of credit risk? 1. Aa rated corporate debenture 2. Baa rated muni rev bond 3. A rated general obligation bond 4. Ba rated corporate mortgage bond

Answer 36

1. The Aa rated corporate debenture. A bonds rating takes into account all factors including collateral and tax base. The higher the rating, the lower the credit risk. So, ignore if these are GO or Rev bonds, just look for the rating

Question 37

Which attracts more investors. Bonds with short term or long term maturities?

Answer 37

Short term