Megan Easton is a portfolio manager with Dynamo Investment Partners (Dynamo) and manages a bond portfolio that invests primarily in investment- grade corporate bonds with a limited amount of US government bonds. Easton meets with John Avelyn, a newly hired analyst, to discuss the structure and management of this investment portfolio, as well as some possible changes to the portfolio composition. Easton begins the meeting by stating her belief that the credit spread is the single most important measure that investors use when selecting bonds. Among the various credit spread measures, including the G- spread, I- spread, and Z- spread, Easton prefers the G- spread. Easton and Avelyn next discuss credit strategy approaches. Dynamo uses a bottom- up approach that selects bonds with the best relative value from the universe of bonds with similar characteristics. Avelyn comments on the following considerations in a bottom- up approach. Comment 1 Callable debt has a smaller option- adjusted spread than comparable non- callable debt. Comment 2 Benchmark corporate bond issues normally have wider spreads than older bonds of the same issuer. Comment 3 The announcement of a new corporate bond issue often leads to an increase in the credit spread on the existing bonds. Dynamo is changing the bond portfolios investment constraints so that it can invest up to 20% of the assets in high- yield corporate bonds and 20% in structured financial instruments. Easton makes the following statement about these changes: Liquidity and trading issues for high- yield bonds, such as investment- grade bonds, will be a key consideration in our security selection. Although both high- yield and investment- grade bonds are quoted as spreads over benchmark government bonds, we must be aware that dealers are likely to hold larger inventories of high- yield bonds and their bidoffer spreads will be larger. Avelyn makes the following statements about the differences between investmentgrade and high- yield bonds. Statement 1 When default losses are low and credit spreads are relatively tight, high- yield bonds tend to perform more like investment grade bonds. Statement 2 Investment- grade bonds have greater exposure to credit risk than high- yield bonds. Statement 3 High- yield bonds have more exposure to interest rate risk than investment- grade bonds. Two of the structured financial instruments that Easton and Avelyn are considering for Dynamos portfolio are collateralized debt obligations (CDOs) and covered bonds. Easton and Avelyn make the following comments about the securities. Easton: If the correlation of the expected defaults on the CDO collateral of the senior and subordinated tranches is positive, the relative value of the mezzanine tranche compared with the senior and equity tranches will increase. Avelyn: Replacing a portion of the corporate bonds with CDOs will provide meaningful diversification to the investment portfolio. Avelyn: Investing in covered bonds will give us the yield increase we are seeking compared with investing in corporate bonds or asset- backed securities.

Please answer these questions based on information

1. A benefit of Eastons preferred credit spread measure is that it:

A. uses swap rates denominated in the same currency as the credit security.

B. provides a good measure of credit spread for bonds with optionality.

C. reduces the potential for maturity mismatch

2. Which of the following is most likely to be used when selecting securities based on Dynamos credit strategy approach?

A. Expected excess returns

B. Macro Factors

C. Average OAS

3. Which of Avelyns comments regarding considerations in the bottom- up approach is most accurate?

A. Comment 3

B. Comment 1

C. Comment 2

4. Which of Eastons statements about the liquidity and trading characteristics of high- yield and investment- grade bonds is most correct?

A. The bidoffer spread of high- yield bonds is normally larger than that of investment- grade bonds with similar maturities.

B. Dealers generally hold larger inventories of high- yield bonds than investment- grade bonds.

C. Both high- yield and investment- grade bonds are quoted as spreads over benchmark government bonds.