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BUS 439 Midterm 2
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Terms in this set (114)
Inverse yield curve refers to a scenario in which
Short-term rates are higher than long-term rates.
TIPS work on the following rule:
The principal is adjusted based on the inflation rate.
Forward rates are
Expected spot rates in future
On-the-run treasury securities are
Most recently auctioned issues.
The benchmark for yield curve in the US is:
Treasury bonds and bills
To construct the spot rate curve, we need
At least a couple of zero-coupon bonds.
What is the problem with using yield curve for pricing new bonds?
It does not provide separate discount rates for different cash-flows
Treasury bills are always
Discount bonds
Swap yield curve is used in countries where
Not sufficient government securities has been issued.
Credit quality of the government sector is a concern.
There are special regulatory treatment of the government securities.
Liquidity theory suggests
Implied forward rates will not be unbiased estimates of future interest rates.
The yield curve is in the positive-slope (i.e., normal) form most of the time because
Market demands a larger yield for longer maturity.
Which one is NOT an example of a structured note?
Treasury note
(ones that ARE:Equity-linked note, Inverse-floating note, Commodity-linked note
Coupon stripping means
A private company issues zero-coupon bond using coupons of treasury securities.
A bond by which one is considered a federal agency security?
Fannie Mae
Rule 144a allows
Trading a privately places security among qualified investors.
Commercial paper refers to
Securities mainly for short-term financing needs.
A non-competitive bid is an offer
Willing to buy certain amount of securities at the yield determined by the auction.
A treasury bill with a face value of $100,000, selling for $98,000, 180 days prior to the maturity. What is bank discount basis for this bond?
4
When a company goes bankrupt,
Some bond holders have higher seniority than others.
A syndicated loan is
The loan offered by a group of banks.
price of a non-callable bond - price of a callable bond = ?
Call option price
Buying a callable bond includes a transaction in which
The buyer sells a call option to issuer.
The price of a callable bond is lower than a regular bond (with similar characteristics) because
It faces the investor to re-investment risks.
Price appreciation potential is limited for a callable bond.
It can be called before the maturity.
To estimate the static spread,
We add static spread to all spot rates and calculate the price of bond.
Interest rates tree is
A graphical representation of possible future forward rates
For a callable bond, the convexity is
Negative
Effective duration takes into account the fact that
When interest rates change, the cash-flow of a callable bond also change.
For any given level of interest-rate volatility, a longer the deferred call makes
The price of the bond higher.
Negative convexity means
Price appreciation will be less than the price depreciation for the same amount of yield change.
When interest rate volatility increases,
The price of callable bonds decrease.
A convertible bond is typically a bond that includes a
Call option on issuing firm's stock
A convertible bond with "protected call" is the one
That can only be called if the price of the underlying stock exceeds aspecified trigger price.
A mandatory convertible is a bond that
Converts automatically at maturity into shares of the issuer's common stock.
What is the "conversion price" if the par value of a bond is $1000 and the conversion ratio is 20?
50
The conversion rate is 20 and the market price of the stock is 35. What is the conversion value?
700
The conversion value is $750 and the market price of the straight bond is $832. What is the minimum price of the convertible bond?
833
What is the premium payback period if the market conversion premium (per share) is $2 and favorable income differential is $0.5?
4
A convertible bond's delta is
The sensitivity of its value to a change in the underlying stock's price.
Which one is not a major risk for convertible bonds?
All three are risks for the buyer.
A convertible bond arbitrage is mainly based on
Mispricing of the embedded convertible option
Utility companies typically have a low credit risk because
Their revenue is not very volatile.
Which one is NOT a key factor in determining credit risk of bonds?
The ratio of stock price to the average bond prices of the company.
Enron's creditors made a large loss after the corporate scandal. This is an example of a
Corporate Governance risk
Interest coverage ratio
Is the number of times interest charges are covered by the pre-tax income.
Which one is not an example of a reasonable bond covenant?
Keeping the equity price above a certain level.
Why one is NOT a key difficulty in building accurate credit risk models?
Lack of historical data on stock prices
key difficulties:
Diversity of industries and corporations
Diversity of causes of default
Lack of proper historical data on defaults
The maintenance test requires the issuer to
Maintain the coupon rate higher than a certain level.
The key idea underlying structural models of credit risk is
A company defaults if the value of its assets falls below a certain level.
Which one is an example of a structural credit risk model?
Black-Scholes-Merton (BSM)
From the perspective of structural credit risk models, the equity-holders of a company
Own a call-option on firm's assets.
Default rate is 5% and the recovery rate is 40%. What is the default loss rate?
3%
Under which theory, forward rates are unbiased predictor of future rates?
pure expectations theory
On a binomial tree used for pricing a callable bond with a par value of $100, you note that the expected present values on many nodes turn out to be significantly larger than $100. Which statement is correct?
The value of the call option is significant.
On a binomial tree used for pricing a puttable bond with a par value of $100, you note that the expected present values on all nodes turn out to be larger than $100. Which statement is correct?
The price of puttable and non-puttable bonds would be very close to each other.
Why do people say "the price of callable bond is less than a similar non-callable bond."?
Because the buyer indeed sells an option to the issuer.
The price of a non-callable bond is $101 and the value of embedded call is $3. What is the price of callable bond?
$98
Which one is NOT an example of a structured note?
Treasury note
In terms of seniority, which ordering is correct? (> means higher)
Secured debt > debenture bond > subordinated debt
Consider a puttable bond, a regular (non-callable) and a callable bond issued by the same issuer with the same term to maturity. When the volatility increases from 10% to 15%, the difference between the price of callable bond and puttable bond increases by $2. In this case, the gap between the price of non-callable (regular) and callable bonds ...
Increases by less than $2
When a company goes bankrupt,
Some bond holders have higher seniority than others.
We are pricing a callable bond with a par value of $100. In a node, we get $104.23 as the expected present value of future cash-flows. Which number should we use as the value in this node?
$100
An investment bank has issued a bond whose final payment is equal to a constant face value + max {gold price-1800, 0}. Which kind of bond is this?
Commodity-linked note (CLN)
A company filed for bankruptcy and went through "reorganization". This means:
A new corporate emerged with a new ownership structure.
When the volatility of short-term interest rates increases,
The price of regular bonds don't change much.
"Forward rates are very poor predictors of the actual future rates". This statement strongly is in contrast with which theory?
Pure expectations theory
Which one is an example of an asset-back debt instrument?
Student loans
, Not Selected
Correct answer:
All three are examples of asset-back debt
Auto loans
, Not Selected
Credit-card loans
What is the equivalent of "present value" in the bond market?
Market price
You receive a complex bond (aka structured product) but have no idea how to model its risks. This can be an example of
Risk risk
Which one is better considered as a "current event" for the fixed income markets?
Covid-19 and corporate bond markets
Which Excel formula is used to calculate the interest rate of a cash-flow stream?
RATE
Which topic will be covered in this course?
Bond Price Volatility
Which one is a key feature of a bond?
Coupon price
, Not Selected
Correct answer:
All three are key features
Maturity date
, Not Selected
Face value
Which number is the closest to the size of US bond market?
$45000 billion
The price of a discount bond
Increases toward the maturity.
Which one is a short-maturity debt instrument?
Treasury Bill
To find the yield of a portfolio,
First calculate the total cash-flow in each period and then calculate the yield
Yield to call is important because
Affects to maturity date if the the issuers calls the bond
The dirty price of a bond is
The price that includes the accrued interest.
the relationship between price and yield of an option-free bond is
Convex
The problem with "current yield" is that:
It does not take account the capital gain
Which type of bond has the least concern about inflation?
Floating-rate bonds
What was the highest level of LIBOR in the period between 2000-2020?
5%
Which one is NOT a major bond price risk factor?
Flight risk
Look at the price of the Apple bond. Which statement is the most accurate for explaining why the price so different after 2019?
Because market rates are low in recent months.
The convexity of a bond
Corrects the error due to the linear approximation of duration
Why duration is an OK measure for small changes in the YTM?
Because the price moves roughly the same in both direction
Modified duration is always ... than the Macaulay duration.
Smaller
A higher coupon rate, makes the duration of the bond
Smaller
for all option-free bonds modified duration is
Positive
The duration of a portfolio
Is the weighted average of the duration of its assets.
The Macaulay duration
The approximate change in price for a small change in yield.
Which feature does NOT affect the percentage sensitivity of bond price to interest rate?
Face value
Current yield becomes closer to yield-to-maturity when
Coupon rate is larger
If an investor may have to sell a bond prior to maturity and interest rates have risen since the bond was purchased, the investor is exposed to
capital loss risk
If market rates remain constant, the price of a par bond will ... as we approach the maturity date.
remains almost the same
To find the yield of a portfolio,
none of them are accurate
Bond Equivalent Yield
Doubles the periodic interest rate calculated for a bond with semi-annual coupon.
If a mortgage borrower prepays the loan earlier, the issuer faces
volatility risk
Which component is NOT part of the bond indenture?
yield to maturity
Amortization means that the principal
Is repaid over the life of the bond.
What is the drawback of using discount margin as a potential return of a floating rate bond?
It assumes reference rates won't change in future.
Which one is a complication for pricing bonds?
When the bond is price between coupon dates.
Interest rates are 5% at the end of a year. Interest rates were much lower, around 3%, at the beginning of that year. Investors who bought bonds in Jan of that year, may experience a ... in Nov.
Capital loss
What is a typical way to create an inverse-floating-rate bond?
Use a floating rate bond as a collateral.
Which one is NOT included in the "yield to worst"?
Current yield
Which one is correct for a discount bond?
coupon rate < current yield < YTM
Discount margin is
...
Which bond has a larger duration? (the yield-to-maturity is the same for all)
A 7-year bond with 5% coupon rate.
For a bond holder, an increase in the market interest rate is
Bad news because it means a capital loss.
A coupon reset formula for a floating-rate bond says "1-month LIBOR + 120 basis points". We refer to the 120 basis points as
Quoted margin
Interest rates and bond prices
Move in the opposite direction.
A bond price is quoted as 98. This means
It is a discount bond.
Which feature does NOT affect the percentage sensitivity of bond price to interest rate?
does not: face value
Does: Maturity
Coupon rate
Initial yield
For a premium bond, the total return is ... compared to the current yield.
smaller
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