Question 1

Duration is important in bond portfolio management because
I.it can be used in immunization strategies.
II.it provides a gauge of the effective average maturity of the portfolio.
III.it is related to the interest rate sensitivity of the portfolio.
IV.it is a good predictor of interest rate changes.
A) I and II
B) I and III
C) III and IV
D) I,II,and III
E) I,II,III,and IV

Accepted Answer

Duration is important in bond portfolio management because it can be used in immunization strategies to match the duration of assets and liabilities, and it provides a gauge of the effective average maturity of the portfolio. It is also related to the interest rate sensitivity of the portfolio, as changes in interest rates can affect the duration of the portfolio. However, it is not necessarily a good predictor of interest rate changes, as many other factors can impact interest rates. Therefore, choices I, II, and III are all correct, but choice IV is not necessarily true.

Question 2

Immunization through duration matching of assets and liabilities may be ineffective or inappropriate because
A) conventional duration strategies assume a flat yield curve.
B) duration matching can only immunize portfolios from parallel shifts in the yield curve.
C) immunization only protects the nominal value of terminal liabilities and does not allow for inflation adjustment.
D) both a and c are true.
E) all of these are true.

Accepted Answer

Conventional duration strategies assume a flat yield curve and only protect against parallel shifts, not changes in the shape of the yield curve. Additionally, immunization does not account for inflation adjustments.

Question 3

The curvature of the price-yield curve for a given bond is referred to as the bond's
A) modified duration.
B) immunization.
C) sensitivity.
D) convexity.
E) tangency.

Accepted Answer

The curvature of the price-yield curve is referred to as the bond's convexity. Modified duration measures the sensitivity of a bond's price to changes in interest rates, while immunization is a risk management strategy used to balance interest rate risk and reinvestment risk. Sensitivity is a general term that can refer to various types of risk analysis, and tangency is not a relevant concept in this context.

Question 4

Par value bond F has a modified duration of 9.Which one of the following statements regarding the bond is true?
A) If the market yield increases by 1% the bond's price will decrease by $90.
B) If the market yield increases by 1% the bond's price will increase by $90.
C) If the market yield increases by 1% the bond's price will decrease by $60.
D) If the market yield decreases by 1% the bond's price will increase by $60.
E) None of these is true.

Accepted Answer

The modified duration of 9 indicates that for a 1% increase in yield, the bond's price will decrease by approximately 9% of its par value. If the bond's par value is $1,000, a 9% decrease would be $90.

Question 5

According to the duration concept
A) only coupon payments matter.
B) only maturity value matters.
C) the coupon payments made prior to maturity make the effective maturity of the bond greater than its actual time to maturity.
D) the coupon payments made prior to maturity make the effective maturity of the bond less than its actual time to maturity.
E) discount rates don't matter.

Accepted Answer

The duration concept takes into consideration both the time to maturity and the timing of coupon payments. The coupon payments made prior to maturity reduce the effective maturity of the bond, hence the effective duration is less than the actual time to maturity. This means that changes in interest rates will have a lesser impact on the price of the bond than if it had the same time to maturity but no coupon payments. Hence, the best choice is D.

Question 6

Which of the following offers a bond index?
A) Merrill Lynch
B) Salomon Smith Barney
C) Scotia Capital
D) All of these
E) All but Merrill Lynch

Accepted Answer

All the mentioned institutions, Merrill Lynch, Salomon Smith Barney, and Scotia Capital, offer bond indices.

Question 7

Two bonds are selling at par value and each has 17 years to maturity.The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%.Which of the following is most false about the durations of these bonds?
A) The duration of the higher-coupon bond will be higher.
B) The duration of the lower-coupon bond will be higher.
C) The duration of the higher-coupon bond will equal the duration of the lower-coupon bond.
D) There is no consistent statement that can be made about the durations of the bonds.
E) The duration of the higher-coupon bond will be higher and will equal the duration of the lower-coupon bond;and there is no consistent statement that can be made about the durations of the bonds

Accepted Answer

The answer of Two bonds are selling at par value...

Question 8

The process of unbundling and repackaging the cash flows from one or more bonds into new securities is called
A) speculation.
B) immunization.
C) reverse hedging.
D) interest rate arbitrage.
E) financial engineering.

Accepted Answer

The process described in the question is commonly referred to as financial engineering. Financial engineering involves the use of complex techniques, often involving mathematical models, to create and manage financial instruments and portfolios. The unbundling and repackaging of cash flows from bonds into new securities is a common example of financial engineering in practice.

Question 9

Two bonds are selling at par value and each has 17 years to maturity.The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%.Which of the following is true about the durations of these bonds?
A) The duration of the higher-coupon bond will be higher.
B) The duration of the lower-coupon bond will be higher.
C) The duration of the higher-coupon bond will equal the duration of the lower-coupon bond.
D) There is no consistent statement that can be made about the durations of the bonds.
E) The bond's durations cannot be determined without knowing the prices of the bonds.

Accepted Answer

Duration measures the sensitivity of a bond's price to changes in interest rates, typically indicating how long it takes for a bond to pay back its true cost. A bond with a higher coupon rate will pay back its cost more quickly due to the higher interest payments. Therefore, the bond with the lower coupon rate (6% in this case) will have a higher duration because it pays back its cost more slowly compared to the bond with the higher coupon rate (13%).

Question 10

Which of the following are true about the interest-rate sensitivity of bonds?
I.Bond prices and yields are inversely related.
II.Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.
III.Interest-rate risk is directly related to the bond's coupon rate.
IV.The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at which the bond is currently selling.
A) I and II
B) I and III
C) I,II,and IV
D) II,III,and IV
E) I,II,III,and IV

Accepted Answer

I is true as bond prices and yields have an inverse relationship. When interest rates rise, bond prices fall and vice versa.

II is true as long-term bonds have a longer maturity and therefore expose the bondholder to more interest rate risk than short-term bonds.

III is false as interest rate risk is inversely related to the bond's coupon rate. The lower the coupon rate, the more sensitive the bond's price will be to changes in interest rates.

IV is true as the bond's price sensitivity is highest when the yield to maturity is lowest. As the yield to maturity increases, the price sensitivity decreases.

Question 11

Which of the following two bonds is more price sensitive to changes in interest rates?
1)A par value bond,A,with a 12-year-to-maturity and a 12% coupon rate.
2)A zero-coupon bond,B,with a 12-year-to-maturity and a 12% yield-to-maturity.
A) Bond A because of the higher yield to maturity.
B) Bond A because of the longer time to maturity.
C) Bond B because of the longer duration.
D) Both have the same sensitivity because both have the same yield to maturity.
E) None of these is correct.

Accepted Answer

Bond B, the zero-coupon bond, is more price sensitive to changes in interest rates because it has a longer duration than Bond A. Duration is a measure of the sensitivity of the bond's price to changes in interest rates, and it is influenced by the length of time until the bond matures and the bond's coupon rate. Zero-coupon bonds have a longer duration than similar coupon-paying bonds because the lack of coupons means that all the cash flows occur at the bond's maturity, making the cash flows more sensitive to changes in interest rates. Therefore, Bond B, with a longer duration, is more price sensitive to interest rate changes.

Question 12

Cash flow matching on a multiperiod basis is referred to as a
A) immunization
B) contingent immunization
C) dedication
D) duration matching
E) rebalancing

Accepted Answer

Cash flow matching on a multiperiod basis is referred to as dedication. Immunization refers to matching the duration of assets and liabilities to hedge against interest rate risk. Contingent immunization involves monitoring the portfolio for deviations from the immunization target and taking action if necessary. Duration matching refers to matching the duration of an asset to the duration of a liability. Rebalancing involves adjusting the portfolio to maintain a desired asset allocation.

Question 13

Which of the following researchers have contributed significantly to bond portfolio management theory?
I.Sidney Homer
II.Harry Markowitz
III.Burton Malkiel
IV.Martin Liebowitz
V.Frederick Macaulay
A) I and II
B) III and V
C) III,IV,and V
D) I,III,IV,and V
E) I,II,III,IV,and V

Accepted Answer

The answer of Which of the following researchers have contributed...

Question 14

A substitution swap is an exchange of bonds undertaken to
A) change the credit risk of a portfolio.
B) extend the duration of a portfolio.
C) reduce the duration of a portfolio.
D) profit from apparent mispricing between two bonds.
E) adjust for differences in the yield spread.

Accepted Answer

A substitution swap is typically undertaken to profit from apparent mispricing between two bonds. It involves selling a bond that is overpriced and buying a similar bond that is underpriced. The swap allows the investor to maintain exposure to the market while potentially earning a profit from the mispricing.

Question 15

An analyst who selects a particular holding period and predicts the yield curve at the end of that holding period is engaging in
A) a rate anticipation swap.
B) immunization.
C) horizon analysis.
D) an intermarket spread swap.
E) none of these.

Accepted Answer

Horizon analysis involves selecting a specific holding period and predicting the expected returns and risks associated with an investment over that period. This is distinct from rate anticipation swaps, which involve exchanging fixed and floating rate debt to take advantage of anticipated changes in interest rates, immunization which is managing an investment portfolio to match the duration of its liabilities, and intermarket spread swaps which involve taking advantage of pricing differences between related instruments in different markets.

Question 16

A contract between two parties to exchange a series of cash flows similar to those resulting from an exchange of different types of bonds is called a(n)
A) interest rate swap.
B) yield curve swap.
C) credit spread.
D) notional spread.
E) none of these.

Accepted Answer

An interest rate swap involves exchanging cash flows based on different interest rates, typically fixed versus floating rates, similar to the cash flows resulting from the exchange of bonds with different characteristics. Yield curve swaps and credit spreads are not commonly used terms in the context of swaps, and notional spread refers to the difference between the notional value of two financial instruments. Therefore, A is the correct answer.

Question 17

Consider a bond selling at par with modified duration of 12 years and convexity of 265.A 1 percent decrease in yield would cause the price to increase by 12%,according to the duration rule.What would be the percentage price change according to the duration-with-convexity rule?
A) 21.2%
B) 25.4%
C) 17.0%
D) 13.3%
E) None of these is correct.

Accepted Answer

The percentage price change using the duration-with-convexity rule is calculated as: Change = (-Duration * ΔYield) + (0.5 * Convexity * (ΔYield)^2). Substituting the given values: Change = (-12 * -0.01) + (0.5 * 265 * (0.01)^2) = 0.12 + 0.01325 = 0.13325 or 13.3%.

Question 18

Consider a bond selling at par with modified duration of 10.6 years and convexity of 210.A 2 percent decrease in yield would cause the price to increase by 21.2%,according to the duration rule.What would be the percentage price change according to the duration-with-convexity rule?
A) 21.2%
B) 25.4%
C) 17.0%
D) 10.6%
E) none of these.

Accepted Answer

The duration-with-convexity rule takes into account the curvature of the bond's price-yield relationship, which the duration rule ignores. The percentage price change can be estimated using the following formula:

% Price Change = - Duration x Δy + 0.5 x Convexity x (Δy)^2

where: 
- Duration = 10.6 
- Convexity = 210 
- Δy = 2% = 0.02

% Price Change = -10.6 x 0.02 + 0.5 x 210 x (0.02)^2 = -0.212 + 0.021 = -0.191 
% Price Change = - 19.1%

Therefore, the percentage price change according to the duration-with-convexity rule is approximately 25.4% (21.2% + (-19.1%)). The best choice is B.

Question 19

An active investment strategy
A) implies that market prices are fairly set.
B) attempts to achieve returns greater than those commensurate with the risk borne.
C) attempts to achieve the proper return that is commensurate with the risk borne.
D) requires portfolio managers,while a passive investment strategy does not.
E) occurs when bond portfolio managers are hyperactive.

Accepted Answer

An active investment strategy attempts to achieve returns greater than those commensurate with the risk borne by taking advantage of market inefficiencies and making investment decisions based on research and analysis. This differs from a passive investment strategy, which aims to match the performance of a designated index or benchmark rather than attempting to outperform it.

Question 20

Interest-rate risk is important to
A) active bond portfolio managers.
B) passive bond portfolio managers.
C) both active and passive bond portfolio managers.
D) neither active nor passive bond portfolio managers.
E) obsessive bond portfolio managers.

Accepted Answer

Both active and passive bond portfolio managers need to be aware of interest-rate risk as it can affect the value of their bond holdings. Active managers can actively manage interest-rate risk through adjusting the duration of their portfolios or using other hedging strategies. Passive managers cannot actively manage interest-rate risk, but still need to be aware of it and choose appropriate bond index funds that align with their risk tolerance.

Quiz 14: Financial Statement Analysis

Duration is important in bond portfolio management because I.it can be used in immunization strategies. II.it provides a gauge of the effective average maturity of the portfolio. III.it is related to the interest rate sensitivity of the portfolio. IV.it is a good predictor of interest rate changes.

Immunization through duration matching of assets and liabilities may be ineffective or inappropriate because

The curvature of the price-yield curve for a given bond is referred to as the bond's

Par value bond F has a modified duration of 9.Which one of the following statements regarding the bond is true?

According to the duration concept

Which of the following offers a bond index?

Two bonds are selling at par value and each has 17 years to maturity.The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%.Which of the following is most false about the durations of these bonds?

The process of unbundling and repackaging the cash flows from one or more bonds into new securities is called

Two bonds are selling at par value and each has 17 years to maturity.The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%.Which of the following is true about the durations of these bonds?

Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond,A,with a 12-year-to-maturity and a 12% coupon rate. 2) A zero-coupon bond,B,with a 12-year-to-maturity and a 12% yield-to-maturity.

Cash flow matching on a multiperiod basis is referred to as a

Which of the following researchers have contributed significantly to bond portfolio management theory? I.Sidney Homer II.Harry Markowitz III.Burton Malkiel IV.Martin Liebowitz V.Frederick Macaulay

A substitution swap is an exchange of bonds undertaken to

An analyst who selects a particular holding period and predicts the yield curve at the end of that holding period is engaging in

A contract between two parties to exchange a series of cash flows similar to those resulting from an exchange of different types of bonds is called a(n)

Consider a bond selling at par with modified duration of 12 years and convexity of 265.A 1 percent decrease in yield would cause the price to increase by 12%,according to the duration rule.What would be the percentage price change according to the duration-with-convexity rule?

Consider a bond selling at par with modified duration of 10.6 years and convexity of 210.A 2 percent decrease in yield would cause the price to increase by 21.2%,according to the duration rule.What would be the percentage price change according to the duration-with-convexity rule?

An active investment strategy

Interest-rate risk is important to