Questions and Answers of Bond Markets Analysis And Strategies

How is the value of a swap determined?AppendixLO1
How is the swap rate calculated?AppendixLO1
In determining the cash flow for the floating-rate side of a LIBOR swap, explain how the cash flow is determined.AppendixLO1
Give two interpretations of an interest-rate swap.AppendixLO1
Suppose that a dealer quotes these terms on a five-year swap: fixed-rate payer to pay 9.5% for LIBOR and floating-rate payer to pay LIBOR for 9.2%.a. What is the dealer's bid-asked spread?b. How
Consider an interest-rate swap with these features: maturity is five years, notional principal is $100 million, payments occur every six months, the fixed-rate payer pays a rate of 9.05% and receives
Determine the price of a European put option on a 6.5% four-year Treasury bond with a strike price of 100.25 and two years to expiration assuming the same infor- mation as in Exhibit A.AppendixLO1
Determine the price of a European call option on a 6.5% four-year Treasury bond with a strike price of 100.25 and two years to expiration assuming: (1) the ar- bitrage-free binomial interest-rate
Here is an excerpt from an article titled "Dominguez Barry Looks at Covered Calls," appearing in the July 20, 1992, issue of Derivatives Week, p. 7:SBC Dominguez Barry Funds Management in Sydney,
In implementing a protective put buying strategy, explain the trade-off between the cost of the strategy and the strike price selected.AppendixLO1
Explain why the writer of an option would prefer an option with a high theta (all other factors equal).AppendixLO1
What are the delta and gamma of an option?AppendixLO1
How is the implied volatility of an option determined?AppendixLO1
a. What factors affect the modified duration of an interest-rate option?b. Deep-in-the-money option always provides a higher modified duration for an option than a deep-out-of-the-money option.
"I don't understand how money managers can calculate the duration of an inter- est-rate option. Don't they mean the amount of time remaining to the expiration date?" Respond to this
Does it make sense for an investor who wants to speculate on interest-rate move- ments to purchase an over-the-counter option?AppendixLO1
What is the motivation for the purchase of an over-the-counter option?AppendixLO1
What are the differences between an option on a bond and an option on a bond futures contract?AppendixLO1
Here are some excerpts from an article titled "It's Boom Time for Bond Options as Interest-Rate Hedges Bloom," published in the November 8, 1990, issue of The Wall Street Journal:a. "The threat of a
What arguments would be given by those who feel that the Black-Scholes model does not apply in pricing interest-rate options?AppendixLO1
"There's no real difference between options and futures. Both are hedging tools, and both are derivative products. It's just that with options you have to pay an op- tion premium, whereas futures
What is the intrinsic value and time value of a call option on bond W given the following information? strike price of call option = 97 current price of bond W = 102 call option price = 9 AppendixLO1
An investor wants to protect against a rise in the market yield on a Treasury bond. Should the investor purchase a put option or a call option to obtain protection?AppendixLO1
When the buyer of a put option on a futures contract exercises, explain the result- ing position for the buyer and the writer.AppendixLO1
An investor owns a call option on bond X with a strike price of 100. The coupon rate on bond X is 9% and has 10 years to maturity. The call option expires today at a time when bond X is selling to
Suppose that a life insurance company sells a five-year guaranteed investment contract that guarantees an interest rate of 7.5% per year on a bond-equivalent yield basis (or equivalently, 3.75% every
One of your clients, a newcomer to the life insurance business, questioned you about the following excerpt from Peter E. Christensen, Frank J. Fabozzi, and Anthony Lo- Faso, "Dedicated Bond
Suppose that a client has granted a money manager permission to pursue an ac- tive/immunized combination strategy. Suppose further that the minimum return expected by the client is 9% and that the
In a stochastic liability funding strategy, why is an interest-rate model needed?AppendixLO1
What is a combination matching strategy?AppendixLO1
a. What is a contingent immunization strategy?b. What is the safety net cushion in a contingent immunization strategy?c. Is it proper to classify a contingent immunization as a combination active/im-
Why is there greater risk in a multiperiod immunization strategy than a cash flow-matching strategy?AppendixLO1
Three portfolio managers are discussing a strategy for immunizing a portfolio so as to achieve a target yield. Manager A, whose portfolio consists of Treasury secu- rities and option-free corporates,
"I can immunize a portfolio simply by investing in zero-coupon Treasury bonds." Comment on this statement.AppendixLO1
What are the risks associated with a bond immunization strategy?AppendixLO1
Why must an immunized portfolio be rebalanced periodically?AppendixLO1
a. What is the basic underlying principle in an immunization strategy?b. Why may the matching of the maturity of a coupon bond to the remaining time to maturity of a liability fail to immunize a
What is meant by immunizing a bond portfolio?AppendixLO1
Indicate why you agree or disagree with the following statements.a. "Under FASB 115 all assets must be marked to market."b. "The greater the price volatility of assets classified in the
The following quotes are taken from Phillip D. Parker (Associate General Coun- sel of the SEC), "Market Value Accounting-An Idea Whose Time Has Come?" in Elliot P. Williams (ed.), Managing
If an institution has liabilities that are interest-rate sensitive and invests in a port- folio of common stocks, can you determine what will happen to the institution's economic surplus if interest
a. Why is the interest-rate sensitivity of an institution's assets and liabilities important?b. In 1986, Martin Leibowitz of Salomon Brothers Inc. wrote a paper titled "Total Portfolio Duration: A
Suppose that the present value of the liabilities of some financial institution is $600 million and the surplus $800 million. The duration of the liabilities is equal to 5. Suppose further that the
a. What is the economic surplus of an institution?b. What is the accounting surplus of an institution?c. What is the regulatory surplus of an institution?d. Which surplus best reflects the economic
Why is asset/liability management best described as surplus management?AppendixLO1
Why is it not always simple to estimate the liability of an institution?AppendixLO1
What are the two dimensions of a liability?AppendixLO1
Why is there credit risk in a repo transaction?AppendixLO1
Suppose that a manager buys an adjustable-rate pass-through security backed by Freddie Mac or Fannie Mae, two government-sponsored enterprises. Suppose that the coupon rate is reset monthly based on
Two trustees of a pension fund are discussing repurchase agreements. Trustee A told Trustee B that she feels it is a safe short-term investment for the fund. Trustee B told Trustee A that repurchase
Suppose a manager wants to borrow $50 million of a Treasury security that it plans to purchase and hold for 20 days. The manager can enter into a reverse repo agreement with a dealer firm that would
Suppose that the initial value of an unlevered portfolio of Treasury securities is $200 million and the duration is 7. Suppose further that the manager can borrow $800 million and invest it in the
What is the risk associated with the use of leverage?AppendixLO1
a. What is a rating transition matrix?b. Explain how a rating transition matrix can be used as a starting point in assess- ing how a manager may want to allocate funds to the different credit sectors
The next excerpt is taken from an article titled "Wood Struthers to Add High-Grade Corporates," which appeared in the February 17, 1992, issue of BondWeek, p. 5: Wood Struthers & Winthrop is poised
The following excerpt comes from an article titled "Securities Counselors Eyes Cutting Duration" in the February 17, 1992, issue of BondWeek, p. 5: Securities Counselors of Iowa will shorten the 5.3
In an article titled "Signet to Add Pass-Throughs," which appeared in the Octo- ber 14, 1991, issue of BondWeek, p. 5, it was reported that Christian Goetz, assis- tant vice president of Signet Asset
The following excerpt is taken from an article titled "W.R. Lazard Buys Triple Bs," which appeared in the November 18, 1991, issue of BondWeek, p. 7: W.R. Lazard & Co. is buying some corporate bonds
This excerpt comes from an article titled "Eagle Eyes High-Coupon Callable Cor- porates" in the January 20, 1992, issue of BondWeek, p. 7: If the bond market rallies further, Eagle Asset Management
The following excerpt is taken from an article titled "MERUS to Boost Corpo- rates," which appeared in the January 27, 1992, issue of BondWeek, p. 6: MERUS Capital Management will increase the
The excerpt that follows is taken from an article titled "Smith Plans to Shorten," which appeared in the January 27, 1992, issue of BondWeek, p. 6: When the economy begins to rebound and interest
Explain why in implementing a yield spread strategy it is necessary to keep the dollar duration constant.AppendixLO1
A portfolio manager owns $5 million par value of bond ABC. The bond is trading at 70 and has a modified duration of 6. The portfolio manager is considering swap- ping out of bond ABC and into bond
What is a laddered portfolio?AppendixLO1
Explain why you agree or disagree with the following statements:a. "It is always better to have a portfolio with more convexity than one with less convexity."b. "A bullet portfolio will always
Below are two portfolios with a market value of $500 million. The bonds in both port- folios are trading at par value. The dollar duration of the two portfolios is the same. Bonds Included in
What are the limitations of using duration and convexity measures in active port- folio strategies?AppendixLO1
a. What is an active portfolio strategy?b. What will determine whether an active or a passive portfolio strategy will be pursued?AppendixLO1
What is the essential ingredient in all active portfolio strategies?AppendixLO1
Explain how it can be possible for a portfolio manager to outperform a bench- mark but still fail to meet the investment objective of a client.AppendixLO1
Why might the investment objective of a portfolio manager of a life insurance company be different from that of a mutual fund manager?AppendixLO1
(This question is from CFA Examination III, June 1, 1991, Afternoon Session, Question 13.) Simon Evans, CFA, is researching SOC Corporation, a company that has issued both convertible and straight
A Merrill Lynch note structure called a liquid yield option note (LYON) is a zero- coupon instrument that is convertible into the common stock of the issuer. The conversion ratio is fixed for the
Consider a convertible bond as follows: par value = $1,000 coupon rate 9.5% market price of convertible bond = $1,000 conversion ratio = 37.383 estimated straight value of bond = $510 yield to
This excerpt comes from an article titled "Bartlett Likes Convertibles" in the Oc- tober 7, 1991, issue of BondWeek, p. 7: Bartlett & Co. is selectively looking for opportunities in convertible bonds
Explain the limitation of using premium over straight value as a measure of the downside risk of a convertible bond.AppendixLO1
This excerpt is taken from an article titled "Caywood Looks for Convertibles," which appeared in the January 13, 1992, issue of BondWeek, p. 7: Caywood Christian Capital Management will invest new
What is the difference between a soft put and a hard put?AppendixLO1
In the October 26, 1992, prospectus summary of the Staples 5% convertible sub- ordinated debentures due 1999, the offering stated: "Convertible into Common Stock at a conversion price of $45 per
Suppose that 8% coupon pass-throughs are stripped into two classes. Class X-1 receives 75% of the principal and 10% of the interest. Class X-2 receives 25% of the principal and 90% of the interest.
a. What is a principal-only security? What is an interest-only security?b. How is the price of an interest-only security expected to change when interest rates change?AppendixLO1
Indicate why you agree or disagree with the following statement: "All CMOs are REMICS."AppendixLO1
What is a REMIC?AppendixLO1
What is a whole loan CMO?AppendixLO1
What types of CMO issues require a credit rating?AppendixLO1
What type of prepayment protection is afforded each of the following: (a) a TAC bond; (b) a reverse TAC bond; (c) a VADM?AppendixLO1
a. What is the role of a lockout in a CMO structure?b. Explain why in a reverse PAC bond structure, the longest average life bond can turn out to be effectively a support bond if all the support
21. An issuer is considering the following two CMO structures: STRUCTURE I: Par Amount Coupon Rate Tranche (in millions) (%) A $150 6.50 100 6.75 200 7.25 150 7.75 100 8.00 500 8.50 Tranches A to E
Consider the following CMO structure backed by 8% collateral: Tranche Par Amount (in millions) Coupon Rate (%) ABCD $300 6.50 250 6.75 200 7.25 250 7.75 Suppose that a client wants a notional IO with
The following questions are to be answered by referring to the prospectus supple- ment that appears on pages 291-316. As indicated on pages of the prospectus (pp. 314-315), the structure and the
Suppose that for the first four years of a CMO, prepayments are well within the initial PAC collar. What will happen to the effective upper collar?AppendixLO1
In a CMO structure with several PAC bonds, explain why, when the support bonds are paid off, the structure will be just like a sequential-pay CMO.AppendixLO1
Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million (PAC I), a support bond with a sched- ule (PAC II) with a par value of $100
Suppose that the $1 billion of collateral in Question 14 was divided into a PAC bond with a par value of $800 million and a support bond with a par value of $200 million. Will the PAC bond in this
Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million and a support bond with a par value of $300 million.a. Which of the
Suppose that a PAC bond is created assuming prepayments speeds of 80 PSA and 350 PSA. If the collateral pays at 100 PSA over its life, what will this PAC tranche's average life be?AppendixLO1
Suppose that a savings and loan association has decided to invest in mortgage- backed securities and is considering the following two securities: (i) a Freddie Mac pass-through security with a WAM of
What was the motivation for the creation of PAC bonds?AppendixLO1
Explain the role of a support bond in a CMO structure.AppendixLO1
Describe how the schedule for a PAC tranche is created.AppendixLO1

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