Chapter 11 Managing Bond Portfolios

Chapter 11 - Managing Bond Portfolios

Chapter 11

Managing Bond Portfolios

Multiple Choice Questions

1.All other things equal, which of the following has the longest duration?A.A 30 year bond with a 10% couponB.A 20 year bond with a 9% couponC.A 20 year bond with a 7% couponD.A 10 year zero coupon bond

2.All other things equal, which of the following has the shortest duration?A.A 30 year bond with a 10% couponB.A 20 year bond with a 9% couponC.A 20 year bond with a 7% couponD.A 10 year zero coupon bond

3.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 yearsB.2.15 yearsC.2.29 yearsD.2.53 years

4.All other things equal, which of the following has the longest duration?A.A 20 year bond with a 10% coupon yielding 10%B.A 20 year bond with a 10% coupon yielding 11%C.A 20 year zero coupon bond yielding 10%D.A 20 year zero coupon bond yielding 11%

5.The duration of a perpetuity varies _______ with interest rates.A.directlyB.inverselyC.convexlyD.randomly

6.Because of convexity, when interest rates change the actual bond price will ____________ the bond price predicted by duration.A.always be higher thanB.sometimes be higher thanC.always be lower thanD.sometimes be lower than

7.You find a 5 year AA Xerox bond priced to yield 6%. You find a similar risk 5 year Canon bond priced to yield 6.5%. To take advantage of this you should do which of the following?A.Short the Canon bond and buy the Xerox bondB.Buy the Canon bond and short the Xerox bondC.Short both the Canon bond and the Xerox bondD.Buy both the Canon bond and the Xerox bond

8.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 immunizationB.dedication strategyC.duration analysisD.horizon analysis

9.A bond's price volatility _________ at a/an _________ rate as maturity increases.A.increases; increasingB.increases; decreasingC.decreases; increasingD.decreases; decreasing

10.As a result of bond convexity an increase in a bond's price when yield to maturity falls is ________ the price decrease resulting from an increase in yield of equal magnitude.A.greater thanB.equivalent toC.smaller thanD.The answer is indeterminate.

11.All else equal, bond price volatility is greater for __________.A.higher coupon ratesB.lower coupon ratesC.shorter maturityD.lower default risk

12.______________ is an important characteristic of the relationship between bond prices and yields.A.ConvexityB.ConcavityC.ComplexityD.Linearity

13.Bond prices are _______ sensitive to changes in yield when the bond is selling at a _______ initial yield to maturity.A.more; lowerB.more; higherC.less; lowerD.equally; higher or lower

14.The pioneer of the duration concept was _________.A.Eugene FamaB.John HerzogC.Frederick MacaulayD.Harry Markowitz

15.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 upB.a rate anticipationC.a substitutionD.an intermarket spread

16.The duration of a 5-year zero coupon bond is ____ years.A.4.5B.5.0C.5.5D.3.5

17.A portfolio manager believes interest rates will drop and decides to sell short duration bonds and buy long duration bonds. This is an example of __________ swap.A.a pure yield pick upB.a rate anticipationC.a substitutionD.an inter-market spread

18.Target date immunization would primarily be of interest to _________.A.banksB.mutual fundsC.pension fundsD.individual investors

19.Duration is a concept that is useful in assessing a bond's _________.A.credit riskB.liquidity riskC.price volatilityD.convexity risk

20.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 immunize its interest rate risk. How much of its portfolio should it allocate to the zero coupon bonds to immunize if there are no other assets funding the plan?A.52%B.48%C.33%D.25%

21.You own a bond that has a duration of 6 years. Interest rates are currently 7% but you believe the Fed 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%

22.Given its time to maturity the duration of a zero coupon bond is _________.A.higher when the discount rate is higherB.higher when the discount rate is lowerC.lowest when the discount rate is equal to the risk free rateD.the same regardless of the discount rate

23.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 thanB.equivalent toC.smaller thanD.The answer is indeterminate

24.All other things equal, a bond's duration is _________.A.higher when the yield to maturity is higherB.lower when the yield to maturity is higherC.the same at all yield ratesD.indeterminable when the yield to maturity is high

25.A bank has an average duration of its liabilities equal to 2 years. The bank's average duration of its assets is 3.5 years. The bank's market value of equity is at risk if _______________________.A.interest rates fallB.credit spreads fallC.interest rates riseD.the price of all fixed income securities rises

26.All other things equal, a bond's duration is _________.A.higher when the coupon rate is higherB.lower when the coupon rate is higherC.the same when the coupon rate is higherD.indeterminate when the coupon rate is high

27.Banks and other financial institutions can best manage interest rate risk by _____________.A.maximizing the duration of assets and minimizing the duration of liabilitiesB.minimizing the duration of assets and maximizing the duration of liabilitiesC.matching the durations of their assets and liabilitiesD.matching the maturities of their assets and liabilities

28.In the context of a bond portfolio, price risk and reinvestment rate risk exactly cancel out at a time horizon equal to ____.A.the average bond maturity in the portfolioB.the duration of the portfolioC.the difference between the shortest duration and longest duration of the individual bonds in the portfolioD.the average of the shortest duration and longest duration of the bonds in the portfolio

29.Bond portfolio immunization techniques balance ________ and ________ risk.A.price; reinvestmentB.price; liquidityC.credit; reinvestmentD.credit; liquidity

30.You have purchased a Guaranteed Investment contracts (GICs) 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.$12,565B.$13,000C.$13,401D.$13,676

31.The duration of a portfolio of bonds can be calculated as _______________.A.the coupon weighted average of the durations of the individual bonds in the portfolioB.the yield weighted average of the durations of the individual bonds in the portfolioC.the value weighed average of the durations of the individual bonds in the portfolioD.averages of the durations of the longest and shortest duration bonds in the portfolio

32.Pension fund managers can generally best bring about an effective reduction in their interest rate risk by holding ___________________.A.long maturity bondsB.long duration bondsC.short maturity bondsD.short duration bonds

33.Which of the following is not a type of bond swap used in active portfolio management?A.Inter-market spread swapB.Substitution swapC.Rate anticipation swapD.Asset-liability swap

34.The exchange of one bond for a bond with similar attributes but more attractively priced is called ______________.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

35.Rank the interest sensitivity of the following from most sensitive to an interest rate change to the least sensitive.I. 8% coupon, noncallable 20 year maturity, par bondII. 9% coupon, currently callable 20 year maturity, premium bondIII. Zero coupon, 30 year maturity bondA.I, II, IIIB.II, III, IC.III, I, IID.III, II, I

36.A bond swap made in response to forecasts of interest rate changes is called ______.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

37.Moving to higher yield bonds, usually with longer maturities is called ________.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

38.In a pure yield pickup swap, ________ bonds are exchanged for _________ bonds.A.longer duration; shorter durationB.shorter duration; longer durationC.high coupon; high yieldD.low yield; high yield

39.The duration rule always ________ the value of a bond following a change in its yield.A.under-estimatesB.provides an unbiased estimate ofC.over-estimatesD.The estimated price may be biased either upward or downward, depending on whether the bond is trading at a discount or a premium

40.Where Y = yield to maturity, the duration of a perpetuity would be _________.A.YB.Y/(1 + Y)C.1/YD.(1 + Y)/Y

41.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.7.46B.8.08C.9.02D.10.11

42.A bond has a current price of $1,030. The yield on the bond is 8.00%. If the yield changes from 8.00% to 8.10%, the price of the bond will go down to $1,025.88. The modified duration of this bond is _________.A.4.32B.4.00C.3.25D.3.75

43.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 immunize 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.1.22B.1.50C.1.60D.2.00

44.A perpetuity pays $100 each and every year forever. The duration of this perpetuity will be __________ if its yield is 9%.A.7B.9C.9.39D.12.11

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%.

45.The duration of this bond is _______ years.A.2.44B.3.23C.3.56D.4.10

46.The modified duration of this bond is ______ years.A.4.00B.3.56C.3.36D.3.05

47.A bond has a maturity of 12 years, a duration of 9.5 years at a promised yield rate of 8%. What is the bond's modified duration?A.12 yearsB.11.1 yearsC.9.5 yearsD.8.8 years

48.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%

49.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.$1,035B.$1,036C.$1,094D.$1,124

50.When interest rates increase, the duration of a 20-year bond selling at a premium _________.A.increasesB.decreasesC.remains the sameD.increases at first, then declines

51.Duration facilitates the comparison of bonds with differing ___________.A.default riskB.conversion ratiosC.maturitiesD.yields to maturity

52.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 AAAB.buy both the AA and the AAAC.buy the AAA and short the AAD.short both the AA and the AAA

53.The duration of a bond normally increases with an increase in _________.I. term-to-maturityII. yield-to-maturity.III. coupon rateA.I onlyB.I and II onlyC.II and III onlyD.I, II and III

54.A fixed income portfolio manager sets a minimum acceptable rate of return on the bond portfolio at 5% per year over the next 4 years. The portfolio is currently worth $10 million. One year later interest rates are at 6%. What is the portfolio value trigger point at this time that would require him to immunize the portfolio?A.$12,155,063B.$10,205,625C.$9,627,948D.$10,500,000

55.Compute the duration of an 8%, 5-year corporate bond with a par value of $1000 if yield to maturity of 10%.A.3.92B.4.28C.4.55D.5.00

56.Compute the modified duration of a 9% coupon, 3-year corporate bond with a yield to maturity of 12%.A.2.45B.2.75C.2.88D.3.00

57.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% decreaseB.1.20% increaseC.1.53% increaseD.2.43% decrease

58.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%

59.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.

60.An investor who expects declining interest rates would maximize their capital gain by purchasing a bond that has a ___ coupon and a ___ term to maturity.A.low; longB.high; shortC.high; longD.zero; long

61.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 onlyB.I and II onlyC.II and III onlyD.I, II and III

62.As compared with equivalent maturity bonds selling at par, deep discount bonds will have ________.A.greater reinvestment riskB.greater price volatilityC.less call protectionD.shorter average maturity

Steel Pier Company has issued bonds that pay semiannually with the following characteristics:

63.The modified duration for the Steel Pier bond is ______.A.6.15 yearsB.5.95 yearsC.6.49 yearsD.9.09 years

64.If the bond's coupon was smaller than 10%, the modified duration would be _____ compared to the original modified duration.A.largerB.unchangedC.smallerD.There is not enough information to determine the direction of change

65.If the maturity of the bond was less than 10 years, the modified duration would be _____ compared to the original modified duration.A.largerB.unchangedC.smallerD.There is not enough information to determine the direction of change

66.If the yield to maturity decreases to 8.045% the expected percentage change in the price of the bond using Macauley's duration would be ____, while the expected percentage change in the price of the bond using modified duration would be ____.A.11%, 12%B.12%, 11%C.12%, 12%D.11%, 11%

67.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%

68.When bonds sell above par, what is the relationship of price sensitivity to rising interest rates?A.Price volatility increases at an increasing rateB.Price volatility increases at a decreasing rateC.Price volatility decreases at a decreasing rateD.Price volatility decreases at an increasing rate

69.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 yearsB.8.0 yearsC.10 yearsD.13 years

70.You have an investment that in today's dollars returns 15% of your investment in year 1, 12% in year two, 9% in year 3 and the remainder in year 4. What is the duration of this investment?A.4 yearsB.3.50 yearsC.3.22 yearsD.2.95 years

71.If an investment returns a higher percentage of your money back sooner it will ______.A.be less price volatileB.have a higher credit ratingC.be less liquidD.have a higher modified duration

72.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 tB.the percentage of the future value of the investment received in year tC.the present value of the dollar amount of the investment received in year tD.the percentage of the total present value of the investment received in year t

73.The duration is independent of the coupon rate only for which one of the following?A.Discount bondsB.Premium bondsC.PerpetuitiesD.Short term bonds

74.You have an investment horizon of 6 years. You choose to hold a bond with a duration of 10 years. Your realized rate of return will be larger than the promised yield on the bond if ___________________.A.interest rates increaseB.interest rates stay the sameC.interest rates fallD.one can't tell with the information given

75.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 bondsB.Buy the 5 year bonds and buy the surrounding maturity bondsC.Short the 5 year bonds and short the surrounding maturity bondsD.Short the 5 year bonds and buy the surrounding maturity bonds

76.Market economists all predict a rise in interest rates. An astute bond manager wishing to maximize 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.

77.You have an investment horizon of 6 years. You choose to hold a bond with a duration of 4 years. Your realized rate of return will be larger than the promised yield on the bond if ___________________.A.interest rates increaseB.interest rates stay the sameC.interest rates fallD.one can't tell with the information given

78.What strategy might an insurance company employ to ensure that it will be able to meet the obligations of annuity holders?A.Cash flow matchingB.Index trackingC.Yield pickup swapsD.Substitution swap

79.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 realized rate of return will be the same as the promised yield on the bond ifI. interest rates increaseII. interest rates stay the sameIII. interest rates fallA.I onlyB.II onlyC.I and II onlyD.I, II and III

80.Immunization of coupon paying bonds is not a passive strategy becauseI. the portfolio must be rebalanced every time interest rates changeII. the portfolio must be rebalanced over time even if interest rates don't changeIII. convexity implies duration based immunization strategies don't workA.I onlyB.I and II onlyC.II onlyD.I, II and III

81.Advantages of cash flow matching and dedicated strategies include ______.I. once the cash flows are matched there is no need for rebalancingII. cash flow matching typically earns a higher rate of return than active bond portfolio managementIII. financial institution's liabilities often exceed the maturity of available bonds, making cash matching even more desirableA.I onlyB.II onlyC.I and III onlyD.I, II and III

82.Convexity implies that duration predictions _______.I. underestimate the % increase in bond price when the yield fallsII. underestimate the % decrease in bond price when the yield risesIII. overestimates the % increase in bond price when the yield fallsIV. overestimates the % decrease in bond price when the yield risesA.I and III onlyB.II and IV onlyC.I and IV onlyD.II and III only

83.You have a 25 year maturity 10% coupon, 10% yield bond with duration of 10 years and a convexity of 135.50. If interest rate were to fall 125 basis points your predicted new price for the bond (including convexity) is _________.A.$1098.45B.$1104.56C.$1113.41D.$1124.20

84.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.$638.85B.$642.54C.$666.88D.$705.03

85.Convexity of a bond is ___________.A.the same as horizon analysisB.the rate of change of the price-yield curve divided by bond priceC.a measure of bond durationD.none of the above

Chapter 11 Managing Bond Portfolios Answer Key

Multiple Choice Questions

1.All other things equal, which of the following has the longest duration?A.A 30 year bond with a 10% couponB.A 20 year bond with a 9% couponC.A 20 year bond with a 7% couponD.A 10 year zero coupon bond

Difficulty: Medium2.All other things equal, which of the following has the shortest duration?A.A 30 year bond with a 10% couponB.A 20 year bond with a 9% couponC.A 20 year bond with a 7% couponD.A 10 year zero coupon bond

Difficulty: Medium3.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 yearsB.2.15 yearsC.2.29 yearsD.2.53 years

Difficulty: Hard4.All other things equal, which of the following has the longest duration?A.A 20 year bond with a 10% coupon yielding 10%B.A 20 year bond with a 10% coupon yielding 11%C.A 20 year zero coupon bond yielding 10%D.A 20 year zero coupon bond yielding 11%

Difficulty: Medium5.The duration of a perpetuity varies _______ with interest rates.A.directlyB.inverselyC.convexlyD.randomly

Difficulty: Medium6.Because of convexity, when interest rates change the actual bond price will ____________ the bond price predicted by duration.A.always be higher thanB.sometimes be higher thanC.always be lower thanD.sometimes be lower than

Difficulty: Easy7.You find a 5 year AA Xerox bond priced to yield 6%. You find a similar risk 5 year Canon bond priced to yield 6.5%. To take advantage of this you should do which of the following?A.Short the Canon bond and buy the Xerox bondB.Buy the Canon bond and short the Xerox bondC.Short both the Canon bond and the Xerox bondD.Buy both the Canon bond and the Xerox bond

Difficulty: Medium8.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 immunizationB.dedication strategyC.duration analysisD.horizon analysis

Difficulty: Easy9.A bond's price volatility _________ at a/an _________ rate as maturity increases.A.increases; increasingB.increases; decreasingC.decreases; increasingD.decreases; decreasing

Difficulty: Easy10.As a result of bond convexity an increase in a bond's price when yield to maturity falls is ________ the price decrease resulting from an increase in yield of equal magnitude.A.greater thanB.equivalent toC.smaller thanD.The answer is indeterminate.

Difficulty: Medium11.All else equal, bond price volatility is greater for __________.A.higher coupon ratesB.lower coupon ratesC.shorter maturityD.lower default risk

Difficulty: Easy12.______________ is an important characteristic of the relationship between bond prices and yields.A.ConvexityB.ConcavityC.ComplexityD.Linearity

Difficulty: Medium13.Bond prices are _______ sensitive to changes in yield when the bond is selling at a _______ initial yield to maturity.A.more; lowerB.more; higherC.less; lowerD.equally; higher or lower

Difficulty: Easy14.The pioneer of the duration concept was _________.A.Eugene FamaB.John HerzogC.Frederick MacaulayD.Harry Markowitz

Difficulty: Easy15.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 upB.a rate anticipationC.a substitutionD.an intermarket spread

Difficulty: Easy16.The duration of a 5-year zero coupon bond is ____ years.A.4.5B.5.0C.5.5D.3.5

Difficulty: Easy17.A portfolio manager believes interest rates will drop and decides to sell short duration bonds and buy long duration bonds. This is an example of __________ swap.A.a pure yield pick upB.a rate anticipationC.a substitutionD.an inter-market spread

Difficulty: Easy18.Target date immunization would primarily be of interest to _________.A.banksB.mutual fundsC.pension fundsD.individual investors

Difficulty: Easy19.Duration is a concept that is useful in assessing a bond's _________.A.credit riskB.liquidity riskC.price volatilityD.convexity risk

Difficulty: Easy20.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 immunize its interest rate risk. How much of its portfolio should it allocate to the zero coupon bonds to immunize if there are no other assets funding the plan?A.52%B.48%C.33%D.25%

Durperpetuity = = 26 years15 = (wz)(5) + (1 - wz) 26; wz = 52.38%

Difficulty: Hard21.You own a bond that has a duration of 6 years. Interest rates are currently 7% but you believe the Fed 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%

%(P = (-6) = -1.40%

Difficulty: Medium22.Given its time to maturity the duration of a zero coupon bond is _________.A.higher when the discount rate is higherB.higher when the discount rate is lowerC.lowest when the discount rate is equal to the risk free rateD.the same regardless of the discount rate

Difficulty: Easy23.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 thanB.equivalent toC.smaller thanD.The answer is indeterminate

Difficulty: Medium24.All other things equal, a bond's duration is _________.A.higher when the yield to maturity is higherB.lower when the yield to maturity is higherC.the same at all yield ratesD.indeterminable when the yield to maturity is high

Difficulty: Medium25.A bank has an average duration of its liabilities equal to 2 years. The bank's average duration of its assets is 3.5 years. The bank's market value of equity is at risk if _______________________.A.interest rates fallB.credit spreads fallC.interest rates riseD.the price of all fixed income securities rises

Difficulty: Medium26.All other things equal, a bond's duration is _________.A.higher when the coupon rate is higherB.lower when the coupon rate is higherC.the same when the coupon rate is higherD.indeterminate when the coupon rate is high

Difficulty: Easy27.Banks and other financial institutions can best manage interest rate risk by _____________.A.maximizing the duration of assets and minimizing the duration of liabilitiesB.minimizing the duration of assets and maximizing the duration of liabilitiesC.matching the durations of their assets and liabilitiesD.matching the maturities of their assets and liabilities

Difficulty: Medium28.In the context of a bond portfolio, price risk and reinvestment rate risk exactly cancel out at a time horizon equal to ____.A.the average bond maturity in the portfolioB.the duration of the portfolioC.the difference between the shortest duration and longest duration of the individual bonds in the portfolioD.the average of the shortest duration and longest duration of the bonds in the portfolio

Difficulty: Easy29.Bond portfolio immunization techniques balance ________ and ________ risk.A.price; reinvestmentB.price; liquidityC.credit; reinvestmentD.credit; liquidity

Difficulty: Easy30.You have purchased a Guaranteed Investment contracts (GICs) 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.$12,565B.$13,000C.$13,401D.$13,676

(10,000)(1.05)6 = $13,401

Difficulty: Easy31.The duration of a portfolio of bonds can be calculated as _______________.A.the coupon weighted average of the durations of the individual bonds in the portfolioB.the yield weighted average of the durations of the individual bonds in the portfolioC.the value weighed average of the durations of the individual bonds in the portfolioD.averages of the durations of the longest and shortest duration bonds in the portfolio

Difficulty: Medium32.Pension fund managers can generally best bring about an effective reduction in their interest rate risk by holding ___________________.A.long maturity bondsB.long duration bondsC.short maturity bondsD.short duration bonds

Difficulty: Medium33.Which of the following is not a type of bond swap used in active portfolio management?A.Inter-market spread swapB.Substitution swapC.Rate anticipation swapD.Asset-liability swap

Difficulty: Easy34.The exchange of one bond for a bond with similar attributes but more attractively priced is called ______________.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

Difficulty: Easy35.Rank the interest sensitivity of the following from most sensitive to an interest rate change to the least sensitive.I. 8% coupon, noncallable 20 year maturity, par bondII. 9% coupon, currently callable 20 year maturity, premium bondIII. Zero coupon, 30 year maturity bondA.I, II, IIIB.II, III, IC.III, I, IID.III, II, I

Difficulty: Hard36.A bond swap made in response to forecasts of interest rate changes is called ______.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

Difficulty: Easy37.Moving to higher yield bonds, usually with longer maturities is called ________.A.a substitution swapB.an intermarket spread swapC.rate anticipation swapD.pure yield pickup swap

Difficulty: Easy38.In a pure yield pickup swap, ________ bonds are exchanged for _________ bonds.A.longer duration; shorter durationB.shorter duration; longer durationC.high coupon; high yieldD.low yield; high yield

Difficulty: Easy39.The duration rule always ________ the value of a bond following a change in its yield.A.under-estimatesB.provides an unbiased estimate ofC.over-estimatesD.The estimated price may be biased either upward or downward, depending on whether the bond is trading at a discount or a premium

Difficulty: Medium40.Where Y = yield to maturity, the duration of a perpetuity would be _________.A.YB.Y/(1 + Y)C.1/YD.(1 + Y)/Y

Difficulty: Medium41.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.7.46B.8.08C.9.02D.10.11

(P = = -0.019(P = -0.019 = -Dur ; Dur = 8.08

Difficulty: Medium42.A bond has a current price of $1,030. The yield on the bond is 8.00%. If the yield changes from 8.00% to 8.10%, the price of the bond will go down to $1,025.88. The modified duration of this bond is _________.A.4.32B.4.00C.3.25D.3.75

(P = = -0.004(P = -0.004 = -Dur ; Dur = 4.32DurMOD = = 4

Difficulty: Hard43.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 immunize 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.1.22B.1.50C.1.60D.2.00

(50,000,000)(DA) = (47,000,000) (1.3); DA = 1.22

Difficulty: Medium44.A perpetuity pays $100 each and every year forever. The duration of this perpetuity will be __________ if its yield is 9%.A.7B.9C.9.39D.12.11

Difficulty: MediumA 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%.

45.The duration of this bond is _______ years.A.2.44B.3.23C.3.56D.4.10

Duration = 3.56

Difficulty: Hard46.The modified duration of this bond is ______ years.A.4.00B.3.56C.3.36D.3.05

DurMOD = 3.56/1.06 = 3.36 years

Difficulty: Hard47.A bond has a maturity of 12 years, a duration of 9.5 years at a promised yield rate of 8%. What is the bond's modified duration?A.12 yearsB.11.1 yearsC.9.5 yearsD.8.8 years

DurMOD = 9.5/1.08 = 8.8 years

Difficulty: Easy48.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%

(use financial calculator to calculate PV10%, 20 and PV8%, 19)

Difficulty: Hard49.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.$1,035B.$1,036C.$1,094D.$1,124

Difficulty: Hard50.When interest rates increase, the duration of a 20-year bond selling at a premium _________.A.increasesB.decreasesC.remains the sameD.increases at first, then declines

Difficulty: Easy51.Duration facilitates the comparison of bonds with differing ___________.A.default riskB.conversion ratiosC.maturitiesD.yields to maturity

Difficulty: Easy52.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 AAAB.buy both the AA and the AAAC.buy the AAA and short the AAD.short both the AA and the AAA

Difficulty: Medium53.The duration of a bond normally increases with an increase in _________.I. term-to-maturityII. yield-to-maturity.III. coupon rateA.I onlyB.I and II onlyC.II and III onlyD.I, II and III

Difficulty: Medium54.A fixed income portfolio manager sets a minimum acceptable rate of return on the bond portfolio at 5% per year over the next 4 years. The portfolio is currently worth $10 million. One year later interest rates are at 6%. What is the portfolio value trigger point at this time that would require him to immunize the portfolio?A.$12,155,063B.$10,205,625C.$9,627,948D.$10,500,000

Minimum terminal value = ($10 mill.)(1.05)4 = $12,155,062.50Trigger point value = $12,155,062.50/1.063 = $10,205,625

Difficulty: Hard55.Compute the duration of an 8%, 5-year corporate bond with a par value of $1000 if yield to maturity of 10%.A.3.92B.4.28C.4.55D.5.00

Difficulty: Medium56.Compute the modified duration of a 9% coupon, 3-year corporate bond with a yield to maturity of 12%.A.2.45B.2.75C.2.88D.3.00

Difficulty: Medium57.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% decreaseB.1.20% increaseC.1.53% increaseD.2.43% decrease

((P/P) = - 8.0 (0.0015) = - 0.012

Difficulty: Medium58.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%

Difficulty: Hard59.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.

Difficulty: Easy60.An investor who expects declining interest rates would maximize their capital gain by purchasing a bond that has a ___ coupon and a ___ term to maturity.A.low; longB.high; shortC.high; longD.zero; long

Difficulty: Easy61.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 onlyB.I and II onlyC.II and III onlyD.I, II and III

Difficulty: Easy62.As compared with equivalent maturity bonds selling at par, deep discount bonds will have ________.A.greater reinvestment riskB.greater price volatilityC.less call protectionD.shorter average maturity

Difficulty: EasySteel Pier Company has issued bonds that pay semiannually with the following characteristics:

63.The modified duration for the Steel Pier bond is ______.A.6.15 yearsB.5.95 yearsC.6.49 yearsD.9.09 years

DurMOD = 6.76/1.10 = 6.15 years

Difficulty: Medium64.If the bond's coupon was smaller than 10%, the modified duration would be _____ compared to the original modified duration.A.largerB.unchangedC.smallerD.There is not enough information to determine the direction of change

Difficulty: Easy65.If the maturity of the bond was less than 10 years, the modified duration would be _____ compared to the original modified duration.A.largerB.unchangedC.smallerD.There is not enough information to determine the direction of change

Difficulty: Easy66.If the yield to maturity decreases to 8.045% the expected percentage change in the price of the bond using Macauley's duration would be ____, while the expected percentage change in the price of the bond using modified duration would be ____.A.11%, 12%B.12%, 11%C.12%, 12%D.11%, 11%

%(P = ; %(P is the same using DurMOD

Difficulty: Hard67.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%

FV5coupons = P5Bond = Total Future Value5 = $366.41 + $954.46 = $1,320.87PV0 = $925.50($925.50)(1 + r)5 = $1,320.87; r = 7.37%

Difficulty: Hard68.When bonds sell above par, what is the relationship of price sensitivity to rising interest rates?A.Price volatility increases at an increasing rateB.Price volatility increases at a decreasing rateC.Price volatility decreases at a decreasing rateD.Price volatility decreases at an increasing rate

Difficulty: Medium69.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 yearsB.8.0 yearsC.10 yearsD.13 years

Duration of a zero-coupon bond is equal to its maturity.

Difficulty: Easy70.You have an investment that in today's dollars returns 15% of your investment in year 1, 12% in year two, 9% in year 3 and the remainder in year 4. What is the duration of this investment?A.4 yearsB.3.50 yearsC.3.22 yearsD.2.95 years

Dur = (15%)(1) + (12%)(2) + (9%)(3) + (64%)(4) = 3.22 years

Difficulty: Medium71.If an investment returns a higher percentage of your money back sooner it will ______.A.be less price volatileB.have a higher credit ratingC.be less liquidD.have a higher modified duration

Difficulty: Easy72.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 tB.the percentage of the future value of the investment received in year tC.the present value of the dollar amount of the investment received in year tD.the percentage of the total present value of the investment received in year t

Difficulty: Hard73.The duration is independent of the coupon rate only for which one of the following?A.Discount bondsB.Premium bondsC.PerpetuitiesD.Short term bonds

Difficulty: Medium74.You have an investment horizon of 6 years. You choose to hold a bond with a duration of 10 years. Your realized rate of return will be larger than the promised yield on the bond if ___________________.A.interest rates increaseB.interest rates stay the sameC.interest rates fallD.one can't tell with the information given

Difficulty: Medium75.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 bondsB.Buy the 5 year bonds and buy the surrounding maturity bondsC.Short the 5 year bonds and short the surrounding maturity bondsD.Short the 5 year bonds and buy the surrounding maturity bonds

Difficulty: Medium76.Market economists all predict a rise in interest rates. An astute bond manager wishing to maximize 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.

Difficulty: Medium77.You have an investment horizon of 6 years. You choose to hold a bond with a duration of 4 years. Your realized rate of return will be larger than the promised yield on the bond if ___________________.A.interest rates increaseB.interest rates stay the sameC.interest rates fallD.one can't tell with the information given

Difficulty: Medium78.What strategy might an insurance company employ to ensure that it will be able to meet the obligations of annuity holders?A.Cash flow matchingB.Index trackingC.Yield pickup swapsD.Substitution swap

Difficulty: Medium79.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 realized rate of return will be the same as the promised yield on the bond ifI. interest rates increaseII. interest rates stay the sameIII. interest rates fallA.I onlyB.II onlyC.I and II onlyD.I, II and III

Difficulty: Medium80.Immunization of coupon paying bonds is not a passive strategy becauseI. the portfolio must be rebalanced every time interest rates changeII. the portfolio must be rebalanced over time even if interest rates don't changeIII. convexity implies duration based immunization strategies don't workA.I onlyB.I and II onlyC.II onlyD.I, II and III

Difficulty: Medium81.Advantages of cash flow matching and dedicated strategies include ______.I. once the cash flows are matched there is no need for rebalancingII. cash flow matching typically earns a higher rate of return than active bond portfolio managementIII. financial institution's liabilities often exceed the maturity of available bonds, making cash matching even more desirableA.I onlyB.II onlyC.I and III onlyD.I, II and III

Difficulty: Medium82.Convexity implies that duration predictions _______.I. underestimate the % increase in bond price when the yield fallsII. underestimate the % decrease in bond price when the yield risesIII. overestimates the % increase in bond price when the yield fallsIV. overestimates the % decrease in bond price when the yield risesA.I and III onlyB.II and IV onlyC.I and IV onlyD.II and III only

Difficulty: Hard83.You have a 25 year maturity 10% coupon, 10% yield bond with duration of 10 years and a convexity of 135.50. If interest rate were to fall 125 basis points your predicted new price for the bond (including convexity) is _________.A.$1098.45B.$1104.56C.$1113.41D.$1124.20

PV0 = $1,000%(P = PNew = ($1,000)(1 + 0.1242) = $1,124.20

Difficulty: Hard84.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.$638.85B.$642.54C.$666.88D.$705.03

PV0 = $805.76%(P = PNew = ($805.76)(1 + -0.1724) = $666.88

Difficulty: Hard85.Convexity of a bond is ___________.A.the same as horizon analysisB.the rate of change of the price-yield curve divided by bond priceC.a measure of bond durationD.none of the above

Difficulty: Medium11-1