Question
You manage a portfolio of bonds on behalf of wealthy investors with maturities spread across the yield curve from three months to ten years. You
You manage a portfolio of bonds on behalf of wealthy investors with maturities spread across the yield curve from three months to ten years. You have received highly regarded advice that suggests changes to medium and long term interest rates which will have an adverse impact on the value of the portfolio. Which one of the following actions will best hedge the impact of such an adverse change on the portfolio? [Note: assume ten year bond futures and ten year swaps]
A. Sell futures and increase the weighting of long-term bonds in the portfolio.
B. Sell futures and negotiate a swap where you pay fixed and receive floating.
C. Sell futures and negotiate a swap where you receive fixed and pay floating.
D. Buy futures and negotiate a swap where you pay fixed and receive floating.
E. Buy futures and negotiate a swap where you receive fixed and pay floating.
If a floating rate borrower hedges their interest rate risk by entering a swap as the fixed rate payer, and the swap subsequently develops a negative value:
A. then the borrower has paid higher than expected interest to their lender.
B. the cost of funds for the borrower will rise.
C. the cost of funds will exceed the swap rate.
D. then the swap has not been an effective hedge.
E. then the borrower has paid lower than expected interest to their lender.
Consider a portfolio of debt (liabilities). Holding all else constant, which one of the following will increase the duration of the portfolio?
A. The coupon on all bonds in the portfolio is increased from 5% to 10%.
B. The portfolio manager negotiates a receive fixed and pay floating swap.
C. The portfolio manager issues two year bonds and uses the proceeds to buy back ten year bonds.
D. The yield curve falls significantly.
E. The portfolio manager buys ten year bond futures.
You are expecting a decline in interest rates over the next few years. As an asset manager, you are offered the following bonds.Which of the bonds is best for you to have in your portfolio? Calculations are not required to answer this question.
Bond A B C D
Coupon rate10% 10% 12% 10%
Yield to maturity8% 7% 7% 7%
Remaining years to maturity 5 5 5 4
A. Bond B.
B. Bond D.
C. Bond C.
D. Bond A.
Which of the following is least likely to be TRUE with respect to swaps?
A. Swaps have little or no regulation.
B. Swaps can be used for the purpose of speculation.
C. Swaps can be used to minimize default risk.
D. Swaps are traded over-the-counter.
E. Swaps can be used for hedging purposes.
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