Deck 10: Managing Bond Portfolios

Question 1

The duration of a 5-year zero coupon bond is ________ years.

A)4.5
B)5.0
C)5.5
D)3.5

Answer 1

B

Question 2

All other things equal, which of the following has the longest duration?

A)A 21-year bond with a 10% coupon yielding 10%
B)A 20-year bond with a 10% coupon yielding 11%
C)A 21-year zero coupon bond yielding 10%
D)A 20-year zero coupon bond yielding 11%

Answer 2

C

Question 3

Banks and other financial institutions can best manage interest rate risk by ________.

A)maximising the duration of assets and minimising the duration of liabilities
B)minimising the duration of assets and maximising the duration of liabilities
C)matching the durations of their assets and liabilities
D)matching the maturities of their assets and liabilities

Answer 3

C

Question 4

An increase in a bond's yield to maturity results in a price decline that is ________ the price increase resulting from a decrease in yield of equal magnitude.

A)greater than
B)equivalent to
C)smaller than
D)The answer is uncertain

Question 5

Because of convexity, when interest rates change the actual bond price will ________ the bond price predicted by duration.

A)always be higher than
B)sometimes be higher than
C)always be lower than
D)sometimes be lower than

Question 6

Target date immunisation would primarily be of interest to ________.

A)banks
B)mutual funds
C)pension funds
D)individual investors

Question 7

Bond portfolio immunisation techniques balance ________ and ________ risk.

A)price; reinvestment
B)price; liquidity
C)credit; reinvestment
D)credit; liquidity

Question 8

________ is an important characteristic of the relationship between bond prices and yields.

A)Convexity
B)Concavity
C)Complexity
D)Linearity

Question 9

A portfolio manager sells Treasury bonds and buys corporate bonds because the spread between corporate and Treasury bond yields is higher than its historical average. This is an example of ________ swap.

A)a pure yield pick up
B)a rate anticipation
C)a substitution
D)an intermarket spread

Question 10

All else equal, bond price volatility is greater for ________.

A)higher coupon rates
B)lower coupon rates
C)shorter maturity
D)lower default risk

Question 11

Bond prices are ________ sensitive to changes in yield when the bond is selling at a ________ initial yield to maturity.

A)more; lower
B)more; higher
C)less; lower
D)equally; higher or lower

Question 12

Duration is a concept that is useful in assessing a bond's ________.

A)credit risk
B)liquidity risk
C)price volatility
D)convexity risk

Question 13

A bond's price volatility ________ at a/an ________ rate as maturity increases.

A)increases; increasing
B)increases; decreasing
C)decreases; increasing
D)decreases; decreasing

Question 14

A pension fund must pay out $1 million next year, $2 million the following year and then $3 million the year after that. If the discount rate is 8% what is the duration of this set of payments?

A)2.00 years
B)2.15 years
C)2.29 years
D)2.53 years

Question 15

The duration of a perpetuity varies ________ with interest rates.

A)directly
B)inversely
C)convexly
D)randomly

Question 16

A bank's liabilities have an average duration of 2 years. Its assets have an average duration of 3.5 years. The bank's market value of equity is at risk if ________.

A)interest rates fall
B)credit spreads fall
C)interest rates rise
D)the price of all fixed income securities rises

Question 17

All other things equal, which of the following has the longest duration?

A)A 30-year bond with a 10% coupon
B)A 20-year bond with a 9% coupon
C)A 20-year bond with a 7% coupon
D)A 10-year zero coupon bond

Question 18

You own a bond that has a duration of 6 years. Interest rates are currently 7% but you believe the Reserve Bank is about to increase interest rates by 25 basis points. Your predicted price change on this bond is ________.

A)+1.40%
B)-1.40%
C)-2.51%
D)+2.51%

Question 19

A pension fund has an average duration of its liabilities equal to 15 years. The fund is looking at 5-year maturity zero coupon bonds and 4% yield perpetuities to immunise its interest rate risk. How much of its portfolio should it allocate to the zero coupon bonds to immunise if there are no other assets funding the plan?

A)52%
B)48%
C)33%
D)25%

Question 20

A forecast of bond returns based largely on a prediction of the yield curve at the end of the investment horizon is called a ________.

A)contingent immunisation
B)dedication strategy
C)duration analysis
D)horizon analysis

Question 21

The exchange of one bond for a bond with similar attributes but more attractively priced is called ________.

A)a substitution swap
B)an intermarket spread swap
C)rate anticipation swap
D)pure yield pickup swap

Question 22

Compute the duration of an 8%, 5-year corporate bond with a par value of $1000 if yield to maturity is 10%.

A)3.92
B)4.28
C)4.55
D)5.00

Question 23

An 8%, 30-year bond has a yield-to-maturity of 10% and a modified duration of 8.0 years. If the market yield drops by 15 basis points, there will be a ________ in the bond's price.

A)1.15% decrease
B)1.20% increase
C)1.53% increase
D)2.43% decrease

Question 24

Rank the interest sensitivity of the following from most sensitive to an interest rate change to the least sensitive.
I) 8% coupon, non-callable 20-year maturity, par bond
II) 9% coupon, currently callable 20-year maturity, premium bond
III) Zero coupon, 30-year maturity bond

A)I, II, III
B)II, III, I
C)III, I, II
D)III, II, I

Question 25

Which of the following set of conditions will result in a bond with the greatest price volatility?

A)A high coupon and a short maturity.
B)A high coupon and a long maturity.
C)A low coupon and a short maturity.
D)A low coupon and a long maturity.

Question 26

A bond currently has a price of $1 050. The yield on the bond is 6.00%. If the yield increases 25 basis points, the price of the bond will go down to $1 030. The duration of this bond is ________ years.

A)7.46
B)8.08
C)9.02
D)10.11

Question 27

Moving to higher yield bonds, usually with longer maturities is called ________.

A)a substitution swap
B)an intermarket spread swap
C)rate anticipation swap
D)pure yield pickup swap

Question 28

A 20-year maturity bond pays interest of $90 once per year and has a face value of $1 000. Its yield to maturity is 10%. Over the upcoming year, you expect interest rates to decline and that the yield to maturity on this bond will only be 8% a year from now. Using horizon analysis, the return you expect to earn by holding this bond over the upcoming year is ________.

A)10.0%
B)12.0%
C)21.6%
D)29.6%

Question 29

An investor who expects declining interest rates would maximise their capital gain by purchasing a bond that has a ________ coupon and a ________ term to maturity.

A)low; long
B)high; short
C)high; long
D)zero; long

Question 30

A bond with a 9-year duration is worth $1 080.00 and its yield to maturity is 8%. If the yield to maturity falls to 7.84%, you would predict that the new value of the bond will be ________.

A)$1 035
B)$1 036
C)$1 094
D)$1 124

Question 31

To create a portfolio with a duration of 4 years using a 5-year zero-coupon bond and a 3-year 8% annual coupon bond with a yield to maturity of 10%, one would have to invest ________ of the portfolio value in the zero-coupon bond.

A)50%
B)55%
C)60%
D)75%

Question 32

A perpetuity pays $100 each and every year forever. The duration of this perpetuity will be ________ if its yield is 9%.

A)7
B)9
C)9.39
D)12.11

Question 33

When interest rates increase, the duration of a 20-year bond selling at a premium ________.

A)increases
B)decreases
C)remains the same
D)increases at first, then declines

Question 34

The duration of a bond normally increases with an increase in ________.
I) term-to-maturity
II) yield-to-maturity.
III) coupon rate

A)I only
B)I and II only
C)II and III only
D)I, II and III

Question 35

The historical yield spread between the AA bond and the AAA bond has been 25 basis points. Currently the spread is only 9 basis points. If you believe the spread will soon return to its historical levels you should ________.

A)buy the AA and short the AAA
B)buy both the AA and the AAA
C)buy the AAA and short the AA
D)short both the AA and the AAA

Question 36

A bond has a maturity of 12 years and a duration of 9.5 years at a promised yield rate of 8%. What is the bond's modified duration?

A)12 years
B)11.1 years
C)9.5 years
D)8.8 years

Question 37

A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1 000. It matures in four years. Its yield to maturity is currently 6%. The duration of this bond is ________ years.

A)2.44
B)3.23
C)3.56
D)4.10

Question 38

You have purchased a Guaranteed Investment contract (GIC) from an insurance firm that promises to pay you a 5% compound rate of return per year for 6 years. If you pay $10 000 for the GIC today and receive no interest along the way you will get ________ in 6 years (to the nearest dollar).

A)$12 565
B)$13 000
C)$13 401
D)$13 676

Question 39

A bank has $50 million in assets, $47 million in liabilities and $3 million in shareholders' equity. If the duration of its liabilities are 1.3 and the bank wants to immunise its net worth against interest rate risk and thus set the duration of equity equal to zero, it should select assets with an average duration of ________.

A)1.22
B)1.50
C)1.60
D)2.00

Question 40

Pension fund managers can generally best bring about an effective reduction in their interest rate risk by holding ________.

A)long maturity bonds
B)long duration bonds
C)short maturity bonds
D)short duration bonds

Question 41

Advantages of cash flow matching and dedicated strategies include ________.
I) once the cash flows are matched there is no need for rebalancing
II) cash flow matching typically earns a higher rate of return than active bond portfolio management
III) financial institution's liabilities often exceed the maturity of available bonds, making cash matching even more desirable

A)I only
B)II only
C)I and III only
D)I, II and III

Question 42

A zero coupon bond is selling at a deep discount price of $430.00. It matures in 13 years. If the yield to maturity of the bond is 6.7%, what is the duration of the bond?

A)6.7 years
B)8.0 years
C)10 years
D)13 years

Question 43

A bond portfolio manager notices a hump in the yield curve at the five-year point. How might a bond manager take advantage of this event?

A)Buy the 5-year bonds and short the surrounding maturity bonds
B)Buy the 5-year bonds and buy the surrounding maturity bonds
C)Short the 5-year bonds and short the surrounding maturity bonds
D)Short the 5-year bonds and buy the surrounding maturity bonds

Question 44

You have a 15 year maturity 4% coupon, 6% yield bond with duration of 10.5 years and a convexity of 128.75. The bond is currently priced at $805.76. If interest rate were to increase 200 basis points your predicted new price for the bond (including convexity) is ________.

A)$638.85
B)$642.54
C)$666.88
D)$705.03

Question 45

You have an investment horizon of 6 years. You choose to hold a bond with a duration of 4 years. Your realised rate of return will be larger than the promised yield on the bond if ________.

A)interest rates increase
B)interest rates stay the same
C)interest rates fall
D)one can't tell from the information given

Question 46

If you choose a zero coupon bond with a maturity that matches your investment horizon which of the following statements is/are correct?
I) You will have no interest rate risk on this bond.
II) Absent default, you can be sure you will earn the promised yield rate.
III) The duration of your bond is less than the time to your investment horizon.

A)I only
B)I and II only
C)II and III only
D)I, II and III

Question 47

Convexity of a bond is ________.

A)the same as horizon analysis
B)the rate of change of the price-yield curve divided by bond price
C)a measure of bond duration
D)none of the above

Question 48

Immunisation of coupon paying bonds is not a passive strategy because ________.
I) the portfolio must be rebalanced every time interest rates change
II) the portfolio must be rebalanced over time even if interest rates don't change
III) convexity implies duration based immunisation strategies don't work

A)I only
B)I and II only
C)II only
D)I, II and III

Question 49

The duration is independent of the coupon rate only for which one of the following?

A)Discount bonds
B)Premium bonds
C)Perpetuities
D)Short-term bonds

Question 50

What strategy might an insurance company employ to ensure that it will be able to meet the obligations of annuity holders?

A)Cash flow matching
B)Index tracking
C)Yield pickup swaps
D)Substitution swap

Question 51

Which one of the following statements correctly describes the weights used in the Macaulay duration calculation?
The weight in Year t is equal to ________.

A)the dollar amount of the investment received in Year t
B)the percentage of the future value of the investment received in Year t
C)the present value of the dollar amount of the investment received in Year t
D)the percentage of the total present value of the investment received in Year t

Question 52

You have a 25-year maturity 10% coupon, 10% yield bond with duration of 10 years and a convexity of 135.50. If the interest rate were to fall 125 basis points your predicted new price for the bond (including convexity) is ________.

A)$1098.45
B)$1104.56
C)$1113.41
D)$1124.20

Question 53

When bonds sell above par, what is the relationship of price sensitivity to rising interest rates?

A)Price volatility increases at an increasing rate
B)Price volatility increases at a decreasing rate
C)Price volatility decreases at a decreasing rate
D)Price volatility decreases at an increasing rate

Question 54

As compared with equivalent maturity bonds selling at par, deep discount bonds will have ________.

A)greater reinvestment risk
B)greater price volatility
C)less call protection
D)shorter average maturity

Question 55

If an investment returns a higher percentage of your money back sooner it will ________.

A)be less price volatile
B)have a higher credit rating
C)be less liquid
D)have a higher modified duration

Question 56

A 20-year maturity corporate bond has a 6.5% coupon rate (the coupons are paid annually). The bond currently sells for $925.50. A bond market analyst forecasts that in five years, yield rates on these bonds will be at 7.0%. You believe that you will be able to reinvest the coupons earned over the next five years at a 6% rate of return. What is your expected annual compound rate of return if you plan on selling the bond in five years?

A)7.37%
B)7.56%
C)8.12%
D)8.54%

Question 57

Convexity implies that duration predictions ________.
I) underestimate the % increase in bond price when the yield falls
II) underestimate the % decrease in bond price when the yield rises
III) overestimates the % increase in bond price when the yield falls
IV) overestimates the % decrease in bond price when the yield rises

A)I and III only
B)II and IV only
C)I and IV only
D)II and III only

Question 58

You have an investment that in today's dollars returns 15% of your investment in Year 1, 12% in Year 2, 9% in Year 3 and the remainder in Year 4. What is the duration of this investment?

A)4 years
B)3.50 years
C)3.22 years
D)2.95 years

Question 59

Market economists all predict a rise in interest rates. An astute bond manager wishing to maximise her capital gain might employ which strategy?

A)Switch from low duration to high duration bonds.
B)Switch from high duration to low duration bonds.
C)Switch from high grade to low grade bonds.
D)Switch from low coupon to high coupon bonds.

Question 60

You have an investment horizon of 6 years. You choose to hold a bond with a duration of 6 years and continue to match your investment horizon and duration throughout your holding period. Your realised rate of return will be the same as the promised yield on the bond if ________.
I) interest rates increase
II) interest rates stay the same
III) interest rates fall

A)I only
B)II only
C)I and II only
D)I, II and III