Deck 5: Understanding Fixed Income Risk and Return

Question 1

a bond with exactly nine years remaining until maturity offers a 3% coupon rate with annual coupons. The bond, with a yield-to-maturity of 5%, is priced at 85.784357 per
100 of par value. The estimated price value of a basis point for the bond is closest to:

A) 0.0086.
B) 0.0648.
C) 0.1295.

Answer 1

B

Question 2

The "second-order" effect on a bond's percentage price change given a change in yield-to-maturity can be best described as:

A) duration.
B) convexity.
C) yield volatility.

Answer 2

B

Question 3

Which of the following sources of return is most likely exposed to interest rate risk for an investor of a fixed-rate bond who holds the bond until maturity?

A) Capital gain or loss
B) redemption of principal
C) reinvestment of coupon payments

Answer 3

C

Question 4

an investor purchases a bond at a price above par value. two years later, the investor sells the bond. The resulting capital gain or loss is measured by comparing the price at which
The bond is sold to the:

A) carrying value.
B) original purchase price.
C) original purchase price value plus the amortized amount of the premium.

Question 5

The following information relates to Problems
an investor purchases a nine-year, 7% annual coupon payment bond at a price equal to par
value. after the bond is purchased and before the first coupon is received, interest rates increase
to 8%. The investor sells the bond after five years. assume that interest rates remain unchanged
at 8% over the five-year holding period.
assuming that all coupons are reinvested over the holding period, the investor's five-year horizon yield is closest to:

A) 5.66%.
B) 6.62%.
C) 7.12%.

Question 6

Which of the following is most appropriate for measuring a bond's sensitivity to shaping risk?

A) key rate duration
B) effective duration
C) modified duration

Question 7

a bond portfolio consists of the following three fixed-rate bonds. assume annual coupon payments and no accrued interest on the bonds. Prices are per 100 of par value. $$\begin{array} { l r c c c c r } \text { Bond } & \text { Maturity } & \begin{array} { c } \text { Market } \\\text { Value }\end{array} & \text { Price } & \text { Coupon } & \begin{array} { c } \text { Yield-to- } \\\text { Maturity }\end{array} & \begin{array} { r } \text { Modified } \\\text { Duration }\end{array} \\\hline \text { A } & \text { 6 years } & 170,000 & 85.0000 & 2.00 \% & 4.95 \% & 5.42 \\\text { B } & 10 \text { years } & 120,000 & 80.0000 & 2.40 \% & 4.99 \% & 8.44 \\\text { C } & 15 \text { years } & 100,000 & 100.0000 & 5.00 \% & 5.00 \% & 10.38 \\\hline\end{array}$$ The bond portfolio's modified duration is closest to:

A) 7.62.
B) 8.08.
C) 8.20.

Question 8

a bond is currently trading for 98.722 per 100 of par value. if the bond's yield-to-matu- rity (YtM) rises by 10 basis points, the bond's full price is expected to fall to 98.669. if
The bond's YtM decreases by 10 basis points, the bond's full price is expected to increase
To 98.782. The bond's approximate convexity is closest to:

A) 0.071.
B) 70.906.
C) 1,144.628.

Question 9

Which of the following statements about Macaulay duration is correct?

A) a bond's coupon rate and Macaulay duration are positively related.
B) a bond's Macaulay duration is inversely related to its yield-to-maturity.
C) The Macaulay duration of a zero-coupon bond is less than its time-to-maturity.

Question 10

Using the information below, which bond has the greatest money duration per 100 of par value assuming annual coupon payments and no accrued interest? $\begin{array} { l r c c c c } \hline \text { Bond } & \begin{array} { c } \text { Time-to- } \\\text { Maturity }\end{array} & \begin{array} { c } \text { Price Per } 100 \\\text { of Par Value }\end{array} & \text { Coupon Rate } & \begin{array} { c } \text { Yield-to- } \\\text { Maturity }\end{array} & \begin{array} { c } \text { Modified } \\\text { Duration }\end{array} \\\hline \text { A } & 6 \text { years } & 85.00 & 2.00 \% & 4.95 \% & 5.42 \\\text { B } & 10 \text { years } & 80.00 & 2.40 \% & 4.99 \% & 8.44 \\\text { C } & 9 \text { years } & 85.78 & 3.00 \% & 5.00 \% & 7.54 \\\hline\end{array}$

A) bond a
B) bond b
C) bond C

Question 11

a "buy-and-hold" investor purchases a fixed-rate bond at a discount and holds the securi- ty until it matures. Which of the following sources of return is least likely to contribute to
The investor's total return over the investment horizon, assuming all payments are made as
Scheduled?

A) Capital gain
B) Principal payment
C) reinvestment of coupon payments

Question 12

an investor buys a 6% annual payment bond with three years to maturity. The bond has a yield-to-maturity of 8% and is currently priced at 94.845806 per 100 of par. The bond's
Macaulay duration is closest to:

A) 2.62.
B) 2.78.
C) 2.83.

Question 13

The following information relates to Problems
an investor purchases a nine-year, 7% annual coupon payment bond at a price equal to par
value. after the bond is purchased and before the first coupon is received, interest rates increase
to 8%. The investor sells the bond after five years. assume that interest rates remain unchanged
at 8% over the five-year holding period.
The capital gain/loss per 100 of par value resulting from the sale of the bond at the end of the five-year holding period is closest to a:

A) loss of 8.45.
B) loss of 3.31.
C) gain of 2.75.

Question 14

The following information relates to Problems
an investor purchases a nine-year, 7% annual coupon payment bond at a price equal to par
value. after the bond is purchased and before the first coupon is received, interest rates increase
to 8%. The investor sells the bond after five years. assume that interest rates remain unchanged
at 8% over the five-year holding period.
Per 100 of par value, the future value of the reinvested coupon payments at the end of the holding period is closest to:

A) 35.00.
B) 40.26.
C) 41.07.

Question 15

Which of the following statements about duration is correct? a bond's:

A) effective duration is a measure of yield duration.
B) modified duration is a measure of curve duration.
C) modified duration cannot be larger than its Macaulay duration (assuming a positive yield-to-maturity).

Question 16

a limitation of calculating a bond portfolio's duration as the weighted average of the yield durations of the individual bonds that compose the portfolio is that it:

A) assumes a parallel shift to the yield curve.
B) is less accurate when the yield curve is less steeply sloped.
C) is not applicable to portfolios that have bonds with embedded options.

Question 17

an investor buys a three-year bond with a 5% coupon rate paid annually. The bond, with a yield-to-maturity of 3%, is purchased at a price of 105.657223 per 100 of par value.
Assuming a 5-basis point change in yield-to-maturity, the bond's approximate modified
Duration is closest to:

A) 2.78.
B) 2.86.
C) 5.56.

Question 18

The interest rate risk of a fixed-rate bond with an embedded call option is best measured by:

A) effective duration.
B) modified duration.
C) Macaulay duration.

Question 19

a Canadian pension fund manager seeks to measure the sensitivity of her pension lia- bilities to market interest rate changes. The manager determines the present value of the Liabilities under three interest rate scenarios: a base rate of 7%, a 100 basis point increase In rates up to 8%, and a 100 basis point drop in rates down to 6%. The results of the Manager's analysis are presented below: $\begin{array} { l c } \hline\text { Interest Rate Assumption } & \text { Present Value of Liabilities } \\\hline 6 \% & \text { CAD510.1 million } \\7 \% & \text { CAD455.4 million } \\8 \% & \text { CAD373.6 million } \\\hline\end{array}$ The effective duration of the pension fund's liabilities is closest to:

A) 1.49.
B) 14.99.
C) 29.97.

Question 20

assuming no change in the credit risk of a bond, the presence of an embedded put option:

A) reduces the effective duration of the bond.
B) increases the effective duration of the bond.
C) does not change the effective duration of the bond.

Question 21

a manufacturing company receives a ratings upgrade and the price increases on its fixed- rate bond. The price increase was most likely caused by a(n):

A) decrease in the bond's credit spread.
B) increase in the bond's liquidity spread.
C) increase of the bond's underlying benchmark rate.

Question 22

The holding period for a bond at which the coupon reinvestment risk offsets the market price risk is best approximated by:

A) duration gap.
B) modified duration.
C) Macaulay duration.

Question 23

Which of the following statements relating to yield volatility is most accurate? if the term structure of yield volatility is downward sloping, then:

A) short-term rates are higher than long-term rates.
B) long-term yields are more stable than short-term yields.
C) short-term bonds will always experience greater price fluctuation than long-term bonds.

Question 24

an investor purchases an annual coupon bond with a 6% coupon rate and exactly 20 years remaining until maturity at a price equal to par value. The investor's investment horizon is
Eight years. The approximate modified duration of the bond is 11.470 years. The duration
Gap at the time of purchase is closest to:

A) −7.842.
B) 3.470.
C) 4.158.

Question 25

a bond has an annual modified duration of 7.020 and annual convexity of 65.180. if the bond's yield-to-maturity decreases by 25 basis points, the expected percentage price
Change is closest to:

A) 1.73%.
B) 1.76%.
C) 1.78%.

Question 26

a bond has an annual modified duration of 7.140 and annual convexity of 66.200. The bond's yield-to-maturity is expected to increase by 50 basis points. The expected percent-
Age price change is closest to:

Question 27

When the investor's investment horizon is less than the Macaulay duration of the bond she owns:

A) the investor is hedged against interest rate risk.
B) reinvestment risk dominates, and the investor is at risk of lower rates.
C) market price risk dominates, and the investor is at risk of higher rates.