Question 1

You have a 25-year maturity, 10% coupon, 10% yield bond with a duration of 10 years and a convexity of 135.5. If the interest rate were to fall 125 basis points, your predicted new price for the bond (including convexity) is ________.

Accepted Answer

ΔP/P = −D*(Δy) + 0.5(Convexity)(Δy)² D* = D/(1 + y) = 10/1.1 = 9.091 −D*(Δy) = −9.091 × −1.25% = 11.36% 0.5(Convexity)(Δy)² = 0.5(135.5)(−1.25%)² = 1.0586% ΔP/P = = −D*(Δy) + 0.5(Convexity)(Δy)² = 11.36% + 1.0586% = 12.42% Since the bond's coupon rate was equal to its original yield to maturity, the original price was $1,000. New price = $1,000 × 1.12422 = $1,124.22

Question 2

In 2012, the S&P 500 increased 16%. Given the low interest rate environment, many large companies had to pour billions of dollars into their pension funds. This example illustrates ________.

Accepted Answer

The scenario describes a situation where companies had to adjust their pension fund contributions due to changes in interest rates, which is indicative of a duration mismatch between the assets and liabilities of the pension funds.

Question 3

A ________ investment strategy takes market prices of securities as set fairly.

Accepted Answer

A passive investment strategy assumes that market prices of securities are set fairly and attempts to match the performance of a specific market index or benchmark rather than trying to outperform the market through individual stock selection or market timing. This approach typically involves low fees and minimal portfolio turnover, making it a popular choice for long-term investors who prefer a buy-and-hold approach.

Question 4

At a 4% yield, the duration of a perpetuity that pays $100 once a year forever is ________.

Accepted Answer

11eaaae8_8b59_95f0_a4b8_7f4bdf680df7_TB6474_11 = 26 years

Question 5

Convexity of a bond is ________.

Accepted Answer

Convexity is the rate of change of the slope of the price-yield curve divided by the bond price. It is a measure of the curvature of the relationship between bond prices and yields. It helps to estimate the degree of change in bond price when there is a change in the yield of the bond.

Question 6

Which of the following is a strategy to shield net worth from interest rate movements?

Accepted Answer

The answer of Which of the following is a strategy...

Question 7

Which of the following statements is false?

Accepted Answer

C) is false because prices of long-term bonds are generally more sensitive to interest rate changes than prices of short-term bonds. This is due to the fact that the longer the maturity, the greater the duration of the bond, which measures its sensitivity to interest rate changes.

Question 8

Duration measures

Accepted Answer

Duration measures all of the listed options. It is a measure of a bond's sensitivity to changes in interest rates and calculates the weighted average time that the bondholder will receive cash flows from the bond, taking into account the present value of those cash flows. It reflects the average time the bondholder must wait to receive the cash flows promised by the bond.

Question 9

Convexity implies that duration predictions:
I. Underestimate the percentage increase in bond price when the yield falls.
II. Underestimate the percentage decrease in bond price when the yield rises.
III. Overestimate the percentage increase in bond price when the yield falls.
IV. Overestimate the percentage decrease in bond price when the yield rises.

Accepted Answer

Convexity implies that the percentage increase in bond price is greater than the percentage decrease in bond price, resulting in longer duration bonds having greater price sensitivity to falling yields than rising yields. This means that duration predictions overestimate the percentage increase in bond price when the yield falls (III) and overestimate the percentage decrease in bond price when the yield rises (IV). Therefore, options I and IV are correct, leading to choice C as the best answer.

Question 10

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 the interest rate were to increase 200 basis points, your predicted new price for the bond (including convexity) is ________.

Accepted Answer

ΔP/P = −D*(Δy) + 0.5(Convexity)(Δy)² D* = D/(1 + y) = 10.5/1.06 = 9.906 −D*(Δy) = −9.906 × −2% = −19.81% 0.5(Convexity)(Δy)² = 0.5(128.75)(−2%)² = 2.575% ΔP/P = = −D*(Δy) + 0.5(Convexity)(Δy)² = −19.81% + 2.575% = −17.235% New price = $805.76 × (1 − 0.17236) = $666.88

Quiz 11: Managing Bond Portfolios