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You are a Fixed Income Portfolio Manager and has been approached by a potential investor who is new to the bond market. The potential investor
You are a Fixed Income Portfolio Manager and has been approached by a potential investor who is new to the bond market. The potential investor has raised some queries and would like your assistance on the following item as per below:
a What are the three main characteristics a fixed income investor should be aware when investing in a bond instrument. The potential investor would like to buy Bond X described in the exhibit below, for settlement on June
Annual Coupon
Coupon Payment Frequency Semiannual
Interest Payment Dates April and October
Maturity Date October
Day Count Convention
Annual YieldtoMaturity
a What is the price that Bond X settled on June is closest to
Assume that the US Treasury bond that matures on August is priced to yield for settlement on October Coupons are paid semiannually on February and August. The yieldtomaturity is stated on a streetconvention semiannual bond basis. This settlement date is days into a day coupon period, using the actualactual daycount convention. Compute the following for this Treasury bond assuming a bps change in the yieldtomaturity and investment of USDM
b approximate modified duration;
c the approximate Convexity;
d Assuming the approximate effective duration is and approximate convexity of Calculate the estimated convexity adjusted percentage price change resulting from a basis points decrease in yield to maturity.
e Bonds often have embedded optionality with different exercise styles. Distinguish between an AmericanStyle Call, EuropeanStyle Call and BermudaStyle Call bonds and impact of the stated optionality on the yields of the bonds.
f Critically assess the key risks to which a bond investment is exposed to
g Differentiate between a passive bond investment strategy to an active bond investment strategy.
h Critically outline the main sources of profit for an active bond management strategy. Support your response with relevant examples.
i Outline the two components of interest rate risks for a coupon paying bond.
j Differentiate between clean price, dirty price and full price
k For a bond under what conditionals an investors rate of return on a bond investment to equal the bonds YTM
l Assume that the thereare two noncallable fixedcoupon bonds on the same date with the same coupon rate except that one matures in years and the other matures in years. Critically explain the impact on each of the bond for a change in interest rate.
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