INV3702/101/3/2013

Tutorial Letter 101/3/2013

Investments: Fixed Income Analysis

INV3702

Semesters 1 & 2

Department of Finance, Risk Management and Banking

IMPORTANT INFORMATION

Please register as a user of myUnisa as soon as possible. It is free of charge. Visit https://my.unisa.ac.za for details. At myUnisa, you will be able to get in touch with fellow students, submit your assignments, update your details, find self-assessment questions and participate in discussion forums and blogs. It is important that you provide Unisa with your cellular number because important announcements may be sent to you by SMS. Please note that this module carries 12 credits and requires at least 120 hours of study, including the time required to complete the assignments and the examination. Devote at least 120 hours to this module to achieve success. Take note of Rule 12 contained in the my Registration @ Unisa brochure. You must pass at least four modules of 12 credits each or two modules of 24 credits each per year. Students who do not comply with this requirement will be excluded from further admission to the university.

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CONTENTS

Page

1 INTRODUCTION .......................................................................................................................... 3

1.1 Tutorial matter .............................................................................................................................. 3

2 PURPOSE OF AND OUTCOMES FOR THE MODULE .............................................................. 3

2.1 Purpose ........................................................................................................................................ 3

2.2 Outcomes ..................................................................................................................................... 3

3 LECTURERS AND CONTACT DETAILS ..................................................................................... 4

3.1 Lecturers ...................................................................................................................................... 4

3.2 Department ................................................................................................................................... 4

3.3 University ...................................................................................................................................... 4

4 MODULE-RELATED RESOURCES ............................................................................................. 4

4.1 Prescribed books .......................................................................................................................... 4

4.2 Recommended books ................................................................................................................... 5

4.3 Electronic reserves (e-reserves) ................................................................................................... 5

5 STUDENT SUPPORT SERVICES FOR THE MODULE ............................................................... 5

6 MODULE-SPECIFIC STUDY PLAN ............................................................................................. 5

7 MODULE PRACTICAL WORK AND WORK-INTEGRATED LEARNING .................................... 5

8 ASSESSMENT ............................................................................................................................. 5

8.1 Assessment plan .......................................................................................................................... 5

8.2 General assignment numbers ....................................................................................................... 6

8.2.1 Unique assignment numbers ........................................................................................................ 6

8.2.2 Due dates for assignments ........................................................................................................... 7

8.3 Submission of assignments .......................................................................................................... 7

8.4 Assignments ................................................................................................................................. 8

9 OTHER ASSESSMENT METHODS ........................................................................................... 24

10 EXAMINATION .......................................................................................................................... 24

11 FREQUENTLY ASKED QUESTIONS ........................................................................................ 24

12 CONCLUSION ........................................................................................................................... 29

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1 INTRODUCTION

Dear Student

Welcome to the module, Investments: Fixed Income Analysis (INV3702). You have enrolled for an interesting, yet challenging module. On completion of this module, you will be able to value fixed income securities as well as measure and understand interest rate risk. 1.1 Tutorial matter

Your tutorial matter for Investments: Fixed Income Analysis (INV3702) consists of the following: ● A study guide for Investments: Fixed Income Analysis (INV3702) ● Two tutorial letters that you will receive shortly after the closing date of each assignment,

which will contain the solutions to the assignment questions ● Additional resources provided at https://my.unisa.ac.za

2 PURPOSE OF AND OUTCOMES FOR THE MODULE

2.1 Purpose

This module will be useful to students who are in investment management, in particular: fixed income securities; the fundamentals of valuation; bond portfolio management; and interest rate risk. This module is intended mainly for students who intend to pursue the CFA programme in the future. 2.2 Outcomes

On completion of this module, you should be able to

• identify the features of debt securities • assess the risks associated with investing in bonds • identify the various bond sectors and instruments • assess yield spreads • value debt securities • identify yield measures and calculate spot and forward rates • measure interest rate risk • assess the term structure and volatility of interest rates

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3 LECTURERS AND CONTACT DETAILS

3.1 Lecturers

Any enquiries of an academic nature concerning this module, such as an enquiry about a specific calculation in the prescribed book, may be directed (during office hours) to:

Mr V Fick

E-mail: fickv@unisa.ac.za (preferred method of communication)

Fax: 086 569 8842

Tel: 012 429 4457

Ms M Dowelani: email: dowelm@unisa.ac.za

Please mention your student number and module code in all communication with Unisa.

3.2 Department

The Department of Finance, Risk Management and Banking (DFRB) is offering this module. Please note that you may get in touch with fellow students, download study material, submit assignments, change your address and/or examination venue, view your assignment marks, download previous examination papers, and get in touch with your lecturer at https://my.unisa.ac.za.

Academic enquiries may also be made by phoning 012 429 3603. E-mail queries may be sent to finman@unisa.ac.za. 3.3 University

Administrative queries should be directed to the appropriate department as indicated in the my Registration @ Unisa brochure. Examples of administrative queries are registration matters, study material matters, account queries and graduation issues. Registration matters must be directed to econ@unisa.ac.za.

4 MODULE-RELATED RESOURCES

4.1 Prescribed books

You must acquire the following prescribed books:

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Title: Fixed Income Analysis, 2nd edition (2007)

Author: Fabozzi, F.J.

Publisher: John Wiley & Sons, Inc., Hoboken, NJ.

ISBN: 978-0-470-05221-1

Title: Fixed Income Analysis Workbook, 2nd edition (2007)

Author: Fabozzi, F.J.

Publisher: John Wiley & Sons, Inc., Hoboken, NJ.

ISBN: 978-0-470-06919-6

4.2 Recommended books

There are no recommended books.

4.3 Electronic reserves (e-reserves)

There are no e-reserves.

5 STUDENT SUPPORT SERVICES FOR THE MODULE

Important information appears in your my Studies @ Unisa brochure.

6 MODULE-SPECIFIC STUDY PLAN

Use your my Studies @ Unisa brochure for general time management and planning skills. In order to pass the module you are advised to devote at least eight hours per week to reading and summarising, as well as to practising the calculations.

7 MODULE PRACTICAL WORK AND WORK-INTEGRATED LEARNING

None.

8 ASSESSMENT

8.1 Assessment plan

Assignments are seen as part of the learning material for this module. As you do the assignments, study the reading texts, consult other resources, discuss the work with fellow students or tutors, or conduct research, you are actively engaged in learning. You may submit assignments (done on mark-reading sheets) by post or electronically via myUnisa. Assignments may not be submitted by fax or e-mail. For detailed information and requirements as far as assignments are concerned, see the brochure my Studies @ Unisa that you received with your study material.

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Compulsory assignments

There are two compulsory assignments for this module in the form of multiple-choice questions. There are non-negotiable submission deadlines for each of the assignments and you must submit these assignments if you wish to gain admission to the examination. The assignments contribute to your year mark.

Year marks Your year mark, based on the mark obtained for the two compulsory assignments, contributes 10% towards your final mark, while your examination mark contributes 90%. The combined weighted average of your year mark and examination mark must be 50% or higher for you to pass the module. However, you must obtain a minimum of 40% in the examination, regardless of your year mark. If you obtain less than 40% in the examination, your year mark will not be taken into account and you will fail. For example: Assume Assignment 01 mark = 50% and Assignment 02 mark = 90%. These marks each contribute equally to the year mark.

Assignment No

Mark Weight Total

Assignment 1 50% 0.5 25

Assignment 2 90% 0.5 45

1.0 70 x 10% of final = 7%

Assume an examination mark of 50%. 90% of the examination mark = 45%. Final mark = (10% assignment mark) + (90% examination mark) = 7% + 45% = 52% You will need a final mark of at least 40% to qualify for a supplementary examination. 8.2 General assignment numbers

Assignments are numbered consecutively per module, starting at 01.

8.2.1 Unique assignment numbers

Each assignment has been allocated a unique number to identify it in the Unisa assessment plans. Please ensure you always indicate the correct unique number when submitting assignments.

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8.2.2 Due dates for assignments

As indicated earlier, you should preferably submit your assignments at https://my.unisa.ac.za prior to the due date of each assignment. Do not wait until the day before the due date. Technical problems with the computer servers of myUnisa may prevent you from submitting your assignment at the last minute.

If you are unable to submit your assignments via myUnisa, or if you prefer posting it to us as a hard copy, please ensure that your posted assignments reach the Unisa main campus by the due dates. Requests for extensions to assignment due dates will not be granted for any reason. These due dates have been set to allow you sufficient time for the completion of other assignments, and for your preparation for the examination.

Information about whether Unisa has received your assignment and the mark attained for an assignment can be obtained from https://my.unisa.ac.za.

8.3 Submission of assignments

To submit an assignment via myUnisa do the following:

1. Go to myUnisa at https://my.unisa.ac.za.

2. Log in using your student number and password.

3. Select the module.

4. Click on "Assignments" in the left-hand menu.

5. Click on the assignment number you want to submit.

6. Follow the instructions on the screen.

Only if you do not have access to the internet should you submit your assignment by means of a mark-reading sheet and mail it to Unisa. If you are using a mark-reading sheet, remember to

• use an HB pencil

• indicate your student number and the unique number of the assignment on the mark-reading sheet

• follow the instructions for completing mark-reading sheets (Incomplete mark-reading

sheets will be returned to you unmarked.)

• submit the assignment in good time (It must have reached the Unisa main campus by the date indicated in the assignments below. Otherwise, it might not be in time to be marked by the Assignment Section.)

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8.4 Assignments

FIRST SEMESTER

ASSIGNMENT 01 Due date: 14 March 2013

Unique number: 226081 Aim: To evaluate whether you have attained the learning outcomes described in study units 1

to 4 of the study guide Work through study units 1 to 4 and then answer the following questions. Submit your assignment at https://my.unisa.ac.za. Question 1

Consider a R1 million semiannual-pay floating-rate issue where the rate is reset on 1 January and 1 July each year. The reference rate is 6-month LIBOR, and the stated margin is +1.25%. If 6-month LIBOR is 6.5% on 1 July, what will the next semiannual coupon be on this issue?

[1] R38 750 [2] R65 000 [3] R77 500

Question 2

From the perspective of the bondholder, which of the following pairs of options would add value to a straight (option-free) bond?

[1] Put option and conversion option. [2] Call option and conversion option. [3] Prepayment option and put option.

Question 3

Consider R1 000 000 par value, 10-year, 6.5% coupon bonds issued on 1 January 2005. The bonds are callable and there is a sinking fund provision. The market rate for similar bonds is currently 5.7%. The main points of the prospectus are summarised as follows: Call dates and prices:

• From 2005 to 2009: 103 • After 1 January 2010: 102

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Additional information: The bonds are non-refundable. The sinking fund provision requires that the company redeem R100 000 of the principal amount each year. Bonds called under the terms of the sinking fund provision will be redeemed at par. The credit rating of the bonds is currently the same as at issuance. Using only the above information, one can conclude that:

[1] the bonds do not have call protection. [2] the bonds were issued at and currently trade at a premium. [3] given current rates, the bonds will likely be called and new bonds issued.

Question 4

An investor buying bonds on margin:

[1] must pay interest on a loan. [2] actually lends the bonds to a bank or brokerage house. [3] is not restricted by government regulation of margin lending.

Question 5

The current price of a bond is 102.50. If interest rates change by 0.5%, the value of the bond price changes by 2.50. What is the duration of the bond?

[1] 2.44 [2] 2.50 [3] 4.88

Question 6

A non-callable, AA-rated, 5-year zero-coupon bond with a yield of 6% is least likely to have:

[1] default risk. [2] interest rate risk. [3] reinvestment risk.

Question 7

A straight 5% bond has two years remaining to maturity and is priced at R981.67. A callable bond that is the same in every respect as the straight bond, except for the call feature, is priced at R917.60. With the yield curve flat at 6%, what is the value of the embedded call option?

[1] R 45.80 [2] R 64.07 [3] R101.00

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Question 8

If interest rate volatility increases, which of the following bonds will experience a price decrease?

[1] A putable bond. [2] A callable bond. [3] A zero-coupon, option-free bond.

Question 9

An investor holds R100 000 (par value) worth of Treasury Inflation Protected Securities (TIPS) that carry a 2.5% semiannual pay coupon. If the annual inflation rate is 3%, what is the inflation-adjusted principal value of the bond after six months?

[1] R101 500 [2] R102 500 [3] R103 000

Question 10

A Treasury note (T-note) principal strip has six months remaining to maturity. How is its price likely to compare to a 6-month Treasury bill (T-bill) that has just been issued? The T-note price should be:

[1] lower. [2] higher. [3] the same.

Question 11

Compared to negotiable CDs, bankers acceptances:

[1] are more liquid. [2] have shorter maturities on average. [3] are more likely to pay periodic interest.

Question 12

Under the pure expectations theory, an inverted yield curve is interpreted as evidence that:

[1] demand for long-term bonds is falling. [2] investors have very little demand for liquidity. [3] short-term rates are expected to fall in the future.

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Question 13

Assume the following yields for different bonds issued by a corporation: • 1-year bond: 5.50%. • 2-year bond: 6.00%. • 3-year bond: 7.00%.

If a 3-year S.A. Treasury is yielding 5%, then what is the absolute yield spread on the 3-year corporate issue?

[1] 40 bp [2] 100 bp [3] 200 bp

Question 14

Which of the following statements most accurately describes the relationship between the economic health of a nation and credit spreads?

[1] Credit spreads and economic well-being are not correlated. [2] Credit spreads decrease during an expanding economy because corporate cash

flows are expected to rise. [3] Credit spreads increase during an expanding economy because corporations invest

in more speculative projects.

Question 15

Given two bonds that are similar in all respects except tax status, the marginal tax rate that will make an investor indifferent between an 8.2% taxable bond and a 6.2% tax-exempt bond is closest to:

[1] 24.39%. [2] 37.04%. [3] 43.47%.

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FIRST SEMESTER

ASSIGNMENT 02 Due date: 10 April 2013

Unique number: 311457 Aim: To evaluate whether you have attained the learning outcomes described in study units 5

to 8 of the study guide Work through study units 5 to 8 and then answer the following questions. Submit your assignment at https://my.unisa.ac.za.

Question 1 An analyst observes a 5-year, 10% semiannual-pay bond. The face value is R1 000. The analyst believes that the yield to maturity for this bond should be 15%. Based on this yield estimate, the price of this bond would be:

[1] R 828.40 [2] R1 189.53 [3] R1 193.04

Question 2 Two bonds have par values of R1 000. Bond A is a 5% annual-pay, 15-year bond priced to yield 8% as an annual rate. Bond B is a 7.5% annual-pay, 20-year bond priced to yield 6% as an annual rate. The values of these two bonds would be: Bond A Bond B

[1] R740.61 R 847.08 [2] R740.61 R1 172.04 [3] R743.22 R1 172.04

Question 3 Treasury spot rates (expressed as semiannual-pay yields to maturity) are as follows: 6 months = 4%, 1 year = 5%, 1.5 years = 6%. A 1.5-year, 4% Treasury note is trading at R965. The arbitrage trade and arbitrage profit are:

[1] buy the bond, sell the pieces (individual cash flows), earn R7.09 per bond. [2] sell the bond, buy the pieces (individual cash flows), earn R7.09 per bond. [3] sell the bond, buy the pieces (individual cash flows), earn R7.91 per bond.

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Question 4 The value of a 17-year, zero-coupon bond with a maturity value of R100 000 and a semiannual-pay yield of 8.22% is closest to:

[1] R24 618. [2] R25 425. [3] R26 108.

Question 5 A 14% semiannual-pay coupon bond has six years to maturity. The bond is currently trading at par. Using a 25 basis point change in yield, the effective duration of the bond is closest to:

[1] 0.389. [2] 3.889. [3] 3.970.

Question 6 A bond has a convexity of 57.3. The convexity effect if the yield decreases by 110 basis points is closest to:

[1] – 1.673%. [2] + 0.693%. [3] + 1.673%.

Question 7 An analyst has determined that if market yields rise by 100 basis points, a certain high-grade corporate bond will have a convexity effect of 1.75%. Further, she has found that the total estimated percentage change in price from this bond should be –13.35%. Given this information, it follows that the bond’s percentage change in price due to duration is:

[1] – 15.10%. [2] – 11.60%. [3] + 16.85%.

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Question 8 An analyst has noticed lately that the price of a particular bond has risen less when the yield falls by 0.1% than the price falls when rates increase by 0.1%. She could conclude that the bond:

[1] is an option-free bond. [2] has negative convexity. [3] has an embedded put option.

Question 9 Based on semiannual compounding, what would the YTM be on a 15-year, zero-coupon, R1 000 par value bond that is currently trading at R331.40?

[1] 3.750% [2] 5.151% [3] 7.500%

Question 10 Given:

• Current 1-year rate = 5.5% • 1f1 = 7.63% • 1f2 = 12.18% • 1f3 = 15.5%

The value of a 4-year, 10% annual-pay, R1 000 par value bond would be closest to:

[1] R 995.89. [2] R1 009.16. [3] R1 085.62.

Question 11

A bond’s nominal spread, zero-volatility spread, and option-adjusted spread will all be equal for a coupon bond if:

[1] the yield curve is flat. [2] the bond is option free. [3] the yield curve is flat and the bond has no embedded options.

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Question 12

Assume the Treasury spot-rate yield curve is upward sloping. Compared to the nominal yield spread between a Treasury bond and an option-free corporate bond of similar maturity, the Z-spread will be:

[1] equal to the nominal spread. [2] less than the nominal spread. [3] greater than the nominal spread.

Question 13

The following information pertains to an equally weighted U.S. Treasury portfolio: Maturity Key rate duration 3-month 0.06 2-year 0.73 5-year 0.34 10-year 3.09 15-year 0.63 20-year 1.22 25-year 2.19 27-year 3.65 The effective duration of the portfolio for a parallel shift in the yield curve is closest to:

[1] 9.09. [2] 10.29. [3] 11.91.

Question 14

Which of the following statements describes an inverted yield curve?

[1] Short-term rates are higher than long-term rates. [2] Long-term rates are higher than short-term rates. [3] Medium-term rates are higher than both short-term rates and long-term rates.

Question 15

Suppose you observe a 1-year (zero-coupon) Treasury security trading at a yield to maturity of 5% (price of 95.2381% of par). You also observe a 2-year T-note with a 6% coupon trading at a yield to maturity of 5.5% (price of 100.9232). And, finally, you observe a 3-year T-note with a 7% coupon trading at a yield to maturity of 6.0% (price of 102.6730). Assume annual coupon payments. Use the bootstrapping method to determine the 2-year spot rate.

[1] 5.46% [2] 5.51% [3] 5.63%

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SECOND SEMESTER ASSIGNMENT 01 Due date: 29 August 2013 Unique number: 228337 Aim: To evaluate whether you have attained the learning outcomes described in study units 1

to 4 of the study guide Work through study units 1 to 4 and then answer the following questions. Submit your assignment at https://my.unisa.ac.za. Question 1

Which of the following statements is most accurate with regard to floating-rate issues that have caps and floors? .

[1] A cap is an advantage to the bondholder, while a floor is an advantage to the issuer. [2] A floor is an advantage to the bondholder, while a cap is an advantage to the issuer. [3] A floor is an advantage to both the issuer and the bondholder, while a cap is a

disadvantage to both the issuer and the bondholder. Question 2

Which of the following most accurately describes the maximum price for a currently callable bond?

[1] Its par value. [2] The call price. [3] The present value of its par value.

Question 3

Consider R1 000 000 par value, 10-year, 6.5% coupon bonds issued on 1 January 2005. The bonds are callable and there is a sinking fund provision. The market rate for similar bonds is currently 5.7%. The main points of the prospectus are summarised as follows: Call dates and prices:

• From 2005 to 2009: 103 • After 1 January 2010: 102

Additional information: The bonds are non-refundable. The sinking fund provision requires that the company redeem R100 000 of the principal amount each year. Bonds called under the terms of the sinking fund provision will be redeemed at par. The credit rating of the bonds is currently the same as at issuance.

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Which of the following statements about the sinking fund provisions for these bonds is most accurate?

[1] The bonds do not have an accelerated sinking fund provision. [2] An investor would benefit from having his bonds called under the provision of the

sinking fund. [3] An investor will receive a premium if the bond is redeemed prior to maturity under the

provision of the sinking fund.

Question 4

A mortgage is least likely:

[1] a collateralised loan. [2] subject to early retirement. [3] characterised by highly predictable cash flows.

Question 5

A bond with a 7.3% yield has a duration of 5.4 and is trading at R985. If the yield decreases to 7.1%, the new bond price is closest to:

[1] R 974.40 [2] R 995.60 [3] R1 091.40

Question 6 An investor is concerned about interest rate risk. Which one of the following bonds (similar, except for yield and maturity) has the least interest rate risk? The bond with:

[1] 5% yield and 10-year maturity. [2] 5% yield and 20-year maturity. [3] 6% yield and 10 year maturity.

Question 7

A straight 5% bond has two years remaining to maturity and is priced at R981.67 (R1 000 par value). A putable bond, which is the same in every respect as the straight bond except for the put provision, is priced at 101.76 (percent of par value). With the yield curve flat at 6%, what is the value of the embedded put option?

[1] R17.60 [2] R26.77 [3] R35.93

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Question 8

Which one of the following securities will have the least reinvestment risk for a long-term investor?

[1] A 6-month T-bill. [2] A 10-year, zero-coupon bond. [3] A 30-year, prepayable amortising bond.

Question 9

An investor holds R100 000 (par value) worth of TIPS currently trading at par. The coupon rate of 4% is paid semiannually, and the annual inflation rate is 2.5%. What coupon payment will the investor receive at the end of the first six months?

[1] R2 000 [2] R2 025 [3] R2 050

Question 10

Which of the following statements about Treasury securities is most accurate?

[1] Treasury bonds may be used to create Treasury coupon strips. [2] Treasury principal strips are usually created from Treasury bills. [3] Treasury coupon strips make lower coupon payments than Treasury principal strips.

Question 11

Compared to a public offering, a private placement of debt securities likely has:

[1] less liquidity and a lower yield. [2] less liquidity and a higher yield. [3] more liquidity and a lower yield.

Question 12

According to the liquidity preference theory, which of the following statements is least accurate?

[1] All else equal, investors prefer short-term securities over long-term securities. [2] Investors perceive little risk differential between short-term and long-term securities. [3] Borrowers will pay a premium for long-term funds to avoid having to roll over short-

term debt.

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Question 13

Assume the following corporate yield curve: • 1-year bond: 5.00%. • 2-year bond: 6.00%. • 3-year bond: 7.00%.

If a 3-year U.S. Treasury yielding 6% is the benchmark bond, the relative yield spread on the 3-year corporate is:

[1] 1.17%. [2] 16.67%. [3] 14.28%.

Question 14

If a South African investor is forecasting that the yield spread between S.A. Treasury bonds and S.A. corporate bonds is going to widen, which of the following beliefs would he also be most likely to hold?

[1] The economy is going to expand. [2] The economy is going to contract. [3] There will be no change in the economy.

Question 15

Which of the following most accurately describes the relationship between liquidity and yield spreads relative to Treasury issues? All else being equal, bonds with:

[1] less liquidity have lower yield spreads to Treasuries. [2] less liquidity have higher yield spreads to Treasuries. [3] greater liquidity have higher yield spreads to Treasuries.

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SECOND SEMESTER

ASSIGNMENT 02 Due date: 27 September 2013

Unique number: 212936 Aim: To evaluate whether you have attained the learning outcomes described in study units 5

to 8 of the study guide Work through study units 5 to 8 and then answer the following questions. Submit your assignment at https://my.unisa.ac.za.

Question 1 A 20-year, 10% annual-pay bond has a par value of R1 000. What would this bond be trading for if it were being priced to yield 15%?

[1] R685.14 [2] R687.03 [3] R828.39

Question 2 Bond A is a 15-year, 10.5% semiannual-pay bond priced with a yield to maturity of 8%, while Bond B is a 15-year, 7% semiannual-pay bond priced with the same yield to maturity. Given that both bonds have par values of R1 000, the prices of these two bonds would be: Bond A Bond B

[1] R 746.61 R913.54 [2] R1 216.15 R913.54 [3] R1 216.15 R944.41

Question 3 An analyst observes a 20-year, 8% option-free bond with semiannual coupons. The required semiannual-pay yield to maturity on this bond was 8%, but suddenly it drops to 7.25%. As a result of the drop, the price of this bond will:

[1] increase. [2] decrease. [3] stay the same.

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Question 4 A R1 000, 5%, 20-year annual-pay bond has a yield of 6.5%. If the yield remains unchanged, how much will the bond value increase over the next three years?

[1] R13.62 [2] R13.78 [3] R13.96

Question 5 Why is the price/yield profile of a callable bond less convex than that of an otherwise identical option-free bond? The price:

[1] increase is capped from above, at or near the call price as the required yield decreases.

[2] increase is capped from above, at or near the call price as the required yield increases.

[3] decrease is limited from below, at or near the call price as the required yield increases.

Question 6 The modified duration of a bond is 7.87. The percentage change in price using duration for a yield decrease of 110 basis points is closest to:

[1] – 8.657% [2] + 7.155% [3] + 8.657%

Question 7 The total price volatility of a typical noncallable bond can be found by:

[1] adding the bond’s convexity effect to its effective duration. [2] adding the bond’s negative convexity to its modified duration. [3] subtracting the bond’s negative convexity from its positive convexity.

Question 8 Which of the following measures is lowest for a currently callable bond?

[1] Modified duration [2] Effective duration [3] Macaulay duration

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Question 9 An analyst observes a bond with an annual coupon that is being priced to yield 6.350%. What is this issue’s bond equivalent yield?

[1] 3.126% [2] 3.175% [3] 6.252%

Question 10 The 4-year spot rate is 9.45%, and the 3-year spot rate is 9.85%. What is the 1-year forward rate three years from today?

[1] 8.258% [2] 9.850% [3] 11.059%

Question 11

An investor purchases a bond that is putable at the option of the holder. The option has value. He has calculated the Z-spread as 223 basis points. The option-adjusted spread will be:

[1] equal to 223 basis points. [2] less than 223 basis points. [3] greater than 223 basis points.

Question 12

The zero-volatility spread will be zero:

[1] if the yield curve is flat. [2] for a zero-coupon bond. [3] for an on-the-run Treasury bond.

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Question 13

The following information pertains to an equally weighted U.S. Treasury portfolio: Maturity Key rate duration 3-month 0.06 2-year 0.73 5-year 0.34 10-year 3.09 15-year 0.63 20-year 1.22 25-year 2.19 27-year 3.65 What is the impact on the portfolio of a 25 basis point increase in the 5-year rate and a 50 basis point increase in the 20-year rate, holding other key rates constant? The portfolio will decrease in value by:

[1] 0.372%. [2] 0.695%. [3] 0.816%.

Question 14

Which of the following statements concerning yield curve shifts is least accurate?

[1] Butterfly shifts result in a change in curvature. [2] A twist results in a flatter or steeper yield curve. [3] A positive butterfly shift results in more curvature.

Question 15

Suppose you observe a 1-year (zero-coupon) Treasury security trading at a yield to maturity of 5% (price of 95.2381% of par). You also observe a 2-year T-note with a 6% coupon trading at a yield to maturity of 5.5% (price of 100.9232). And, finally, you observe a 3-year T-note with a 7% coupon trading at a yield to maturity of 6.0% (price of 102.6730). Assume annual coupon payments. Use the bootstrapping method to determine the 3-year spot rate.

[1] 5.81% [2] 5.92% [3] 6.05%

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9 OTHER ASSESSMENT METHODS

We will use no other assessment methods.

10 EXAMINATION

Examination admission will be granted to all students who have submitted the compulsory assignment. Students who do not submit the assignment will NOT be allowed to write the examination.

The provisional examination dates have been published on https://my.unisa.ac.za.

The examination paper for INV3702 consists of both multiple-choice and essay questions. Note that multiple-choice questions in the assignments have only three options, but those in the examination will have four options. No equations are provided in the examination. More information will be provided in Tutorial Letter 201.

A student must attain a mark of at least 40% in the examination to qualify for admission to the supplementary examination. Details about the procedure and cost of the re-marking of examination scripts may be found on myUnisa (https://my.unisa.ac.za).

11 FREQUENTLY ASKED QUESTIONS

SECTION A: ADMINISTRATIVE MATTERS

1 MATTERS PERTAINING TO REGISTRATION

What should I do if any of my personal details (name, address, etc) have been incorrectly captured during the registration process?

Please use myUnisa (https://my.unisa.ac.za) to rectify any errors. Alternatively, send an e-mail to econ@unisa.ac.za, or mail us a letter addressed to The Registrar, PO Box 392, Unisa, 0003. Please remember to quote your student number in all correspondence.

What do I need to do to obtain items that had been out of stock when I registered?

Please use the internet facility at https://my.unisa.ac.za to download copies of any of the study material. Alternatively, send an e-mail to despatch@unisa.ac.za. Please remember to quote your student number in all correspondence. Allow about four weeks for delivery of any outstanding items before contacting Unisa about out-of-stock items.

2 ASSIGNMENTS

My assignment is late because .... Can I submit it at a later date?

It is your responsibility to ensure that your assignment is submitted at myUnisa or reaches the Unisa Main Campus on or before the closing date. Please do not call us to request an extension for the submission of an assignment. Once the tutorial letter containing the solutions has been published, you may no longer submit the assignment.

INV3702/101

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Are the assignments of this module compulsory?

The assignments are compulsory. The intention is that you should use the assignments to prepare yourself for the examination.

Do the marks obtained for assignments contribute to the final mark?

The assignment marks do contribute to the final marks, as explained in this tutorial letter.

Who can I contact to find out if Unisa received my assignment(s) that I sent by mail?

Preferably, submit your assignments via myUnisa. If you do not have access to the internet and you have mailed your assignments to Unisa, send an SMS to 43584 to determine if Unisa received your assignment(s).

What do I do if my assignment goes missing in the mail?

Preferably, submit your assignments via myUnisa. Always make a copy of your assignment and keep it in a safe place in case you need to submit a duplicate copy.

Can I submit my assignments by e-mail?

No, all assignments must either be submitted via myUnisa or posted. Assignments e-mailed to lecturers will not be marked.

How long will I have to wait before I can expect my assignment(s) results?

We aim to have assignments marked within three (3) weeks after each due date. Visit https://my.unisa.ac.za to determine what mark you have achieved. Allow an additional week or two for the post office to deliver the results to your postal address. The assignment results will be returned to the postal address that you indicated. Please do not make enquiries about your assignment before four (4) weeks after the due date have elapsed.

Can I expect my assignment to be returned sooner if I submit it well before the due date?

The marking of assignments normally starts on the due dates indicated in this tutorial letters. Assignments are not marked or returned prior to the due dates.

What mark did I obtain for my assignment(s)?

Register as a user of the myUnisa facility and visit https://my.unisa.ac.za to find out the mark you received for your assignment(s).

3 EXAMINATION

What happens if I am unable to write the examination because of ill health, work commitments or any other crisis?

Any requests for aegrotat examinations need to be done in writing and directed to the Head: Examinations, Box 392, Unisa, 0003 or exams@unisa.ac.za. A fee is payable for such requests. The Examination Section determines this amount .

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What happens if I fail any papers?

Students who fail any of the papers may be granted admission to write the supplementary examination scheduled for the next examination, provided they achieved a final mark of at least 40%. Any enquiries in this regard need to be directed to the Head: Examinations, Box 392, Unisa, 0003 or exams@unisa.ac.za

What will happen if I do not write any of the papers during the supplementary examination?

In such a case, you will have to obtain a registration form, complete it, pay the required fees and register again.

What do I need to bring to the examination venue?

Bring your identity document (ID), student card, an HB pencil, black pen, financial calculator, ruler, eraser, and pencil sharpener.

Will it be an open-book examination?

No.

Could you give me an idea of the scope of the examination paper?

The examination paper is based on your prescribed book and the learning outcomes provided in your study guide. Each learning outcome statement and assessment criterion may be used to set examination questions. Please do not call us to enquire about the “scope” of the examination paper.

4 RESULTS

I am going to be away when the examination results are due to be released. Could you please tell me what mark I obtained for this paper?

The results should be available within four (4) weeks after completion of the examination. Please do not call the lecturers to request your results.

How will the results be announced?

The results are normally mailed to students. They are also available at myUnisa (https://my.unisa.ac.za) and via the MTN results facility (cellular number 083 1234).

5 STUDY GUIDE AND TUTORIAL LETTERS

I have lost my study guide and tutorial letters. Could you please mail or fax me a copy?

Please download a copy from myUnisa. Register as a user at https://my.unisa.ac.za. The lecturers do not mail or fax copies of study guides to students. You may also order replacement copies of study guides from Unisa’s Despatch Department. Please send an e-mail to despatch@unisa.ac.za or a letter to The Head: Despatch, PO Box 392, Unisa, 0003.

INV3702/101

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6 CHANGES IN REGISTRATION DETAILS

What do I need to do if I want to add or cancel any of the modules?

Please update your details at myUnisa. Alternatively, send an e-mail, facsimile or letter to indicate any changes that need to be made to your registration. Any such changes must be completed two months before the examination. Please send an e-mail to econ@unisa.ac.za. Alternatively, mail a letter addressed to The Registrar, Box 392, Unisa, 0003. Please remember to quote your student number in all correspondence.

7 ACCOUNTS

What do I do if I do not agree with my account statement?

Please send a letter addressed to The Head: Student Accounts, Box 392, Unisa, 0003.

Alternatively, send an e-mail to finan@unisa.ac.za.

Please provide a copy of your receipt(s), deposit slips or electronic funds transfer (EFT) as proof of payment as well as your student number.

Will the payment immediately appear on my account statement?

Please note that your payment will only be reflected on your next account statement.

SECTION B: ACADEMIC MATTERS

1 THE PRESCRIBED BOOK

May I use any alternative books?

We strongly recommend the use of the prescribed book. You are welcome to consult additional reading material, but the examination paper is based on the prescribed book.

Which specific pages do I need to study and which can I leave out?

The chapters that need to be studied are indicated in your study guide. The study guide will indicate if any pages may be left out. You need to focus on achieving the learning outcomes.

Could you highlight the most important aspects of each chapter?

Some students are inclined to study only the “most important aspects”. This may prove to be disastrous in the examination. All aspects of the prescribed chapters identified by means of the learning outcomes should be regarded as important for the examination.

2 CALCULATORS Am I allowed to use a calculator? Yes. In fact, we would like to encourage you to use a financial calculator.

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I have a scientific calculator. Will it be sufficient for this paper? No. Please use a financial calculator. Which calculator is prescribed or recommended? We recommend the use of the HP10-B II. Am I allowed to use a programmable calculator in the examination? No.

3 SUPPLEMENTARY BOOKS AND VIDEOS

Are there any supplementary books and videos that I can use?

No supplementary books and videos are prescribed.

I would like to do some additional exercises and calculations. Could you provide me with the tutorial letters of 20..?

Because of limited storage space at Unisa, no tutorial letters from previous years are kept and/or made available to students. Visit myUnisa for additional resources, if available.

4 CONTACT WITH FELLOW STUDENTS

I wish to contact other students enrolled for this module in my area. Please provide me with their contact details.

Contact may be established with fellow students at the discussion forum and blog at myUnisa. Due to the constitutional right to privacy, we may not disclose the details of students to their fellow students.

5 EXAMINATION

Are any old examination papers available?

Previous examination papers are published on myUnisa, but no memoranda are made available to students. Old questions will not necessarily be repeated in subsequent examination papers; students are warned not to rely on old examination papers in order to pass the module.

What will the format of the examination paper be?

The format of the examination paper will be confirmed in one of the tutorial letters (normally Tutorial Letter 201) which will be sent to you during the semester.

Will the examination paper contain any theory questions or will there only be calculations and interpretations?

Examination questions may involve theory, application, calculations and interpretation. The entire syllabus is prescribed.

Will all the equations be provided as an annexure to the examination paper?

The equations will not be provided as part of the examination paper. You must be able to apply the equations in the examination. No marks are awarded for quoting equations in the examination script.

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If I study only the assignment questions, will I be adequately prepared for the examination?

No. It is unlikely that you will be adequately prepared by studying only the assignment questions. The assignment questions represent a sample of the work and cannot be regarded as being representative of all the study material.

Can you give me the “scope” of or any “hints” for the examination?

We do not give any “hints” to students. Please do not call the lecturers about the “scope” of or “hints” for the examination. Base your preparation for the examination on the learning outcomes contained in the study guide.

12 CONCLUSION

This tutorial letter provides you with the purpose and outcomes of the module; the contact details of the lecturer; module-related resources; and student support services.

You should now prepare a study plan for yourself and devote 120 hours to this module to be able to achieve success in the examination.

Details of your assessment and of your assignments for the semester have been provided.

We also provided some frequently asked questions (FAQs) to save you a telephone call or an e-mail.

Kind regards Virgil Fick Lecturer: Investments DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING