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Terms in this set (69)
Inverse floater
can give an investor who believes interest rates will decline the opportunity to obtain a higher coupon interest rate
When only a portion of an outstanding bond issue is called
On random basis or On pro rata basis
put provision
The yield on a putable bond is higher than a similar non-putable issue.
collateralization
-The advantage to the investor of using this borrowing arrangement is that the interest rate is less than the cost of bank financing.
-A repo agreement is the sale of a security with a commitment by the seller to buy the same security back from the purchaser at a specified price at a designated future date.
-The repo rate varies from transaction to transaction
Interest rate risk
The risk that an investor faces that the price of a bond held in a portfolio will decline if market interest rates rise
Callable bond
When interest rates drop, the value of a callable bond rises less than the value of a similar option-free bond
The price of a floating-rate security depends on
-Having a cap and therefore being subject to cap risk
-Changes in the required margin that investors demand
-Time to the next coupon reset date
duration
-The accuracy of the duration calculation crucially depends on the validity of the valuation model used
-The percentage price change for a 100 basis point change in yield is called dollar duration.
-Duration is a measure of the price sensitivity of a bond to a change in yield.
zero-coupon bonds have _____ reinvestment risk and ______ interest rate compared to coupon paying bonds.
lower, higher
For all but _____________ , an investor is exposed to inflation risk because the interest rate the issuer promises to make is fixed for the life of the issue.
TIPS
Default frequency on bonds in local currency is ________ than on bonds in foreign currency.
lower than
Government-sponsored enterprises (GSE's)
Freddie Mac
Ginnie Mae
Fannie Mae
collateralized mortgage obligation (CMO)
A participation certificate sold on a pool of mortgages in which investors do not share the prepayment risk equally, but it is ranked in different tranches
Municipal bonds
usually tax-exempt
A majority of studies including Altman place the annual dollar default rates for all original issue high-yield bonds between ____ and ____.
2% and 4%
According to the analysis by Moody's, what is the average recovery rate for all bonds
38%
What is the maximum amount of a certificate of deposit (CD) that is insured by FDIC?
$100,000
Tools Fed uses as interest rate policy
Open market operation
Bank reserve requirements
The discount rate
Federal funds rate
The rate at which U.S. banks borrow and lend funds from each other
Inflation Protection Securities
Coupon securities whose principal's reference rate is the Consumer Price Index.
Treasury Bonds
Coupon securities with maturity at issuance greater than 10 years.
Treasury Notes
Coupon securities with maturity at issuance greater than 1 year but not greater than 10 years.
Zero-coupon securities with a maturity at issuance of one year or less
Treasury bills
The premium that off-the-run Treasury issues must offer as opposed to on-the-run issues reflect the differences in _______ risk.
liquidity risk
Based on pure expectation theory an upward sloping yield curve indicates that
interest rates expected to rise
Credit spreads ________ in a contracting economy and ________ during economic expansion.
widen, narrow
In an interest rate swap the counterparty that agrees to make interest rate payments that float with some reference rate, is referred to as the ___________ .
fixed rate receiver
As a bond moves closer to its maturity date, assuming that the discount rate does not change, a bond's value will
depending on whether is trading at a premium or a discount, may increase or decrease
Day count convention for Treasury securities is _______ , for municipal bonds is ________ and for corporate bonds is __________.
actual/actual, 30/360, 30/360
Arbitrage-free value of a bond must be calculated using ________ as discount rate.
spot rates
when can a dealer gain positive arbitrage profits by stripping a Treasury issue to a package of zero-coupon bonds
When Treasury issue market price is less than the arbitrage-free value of a bond
Reconstitution
The process of putting together a package of Treasury strips to create a synthetic Treasury
credit spread
-Generally, the credit spread increases with maturity.
-There is no reason to expect the credit spread to be the same regardless of when the cash flow is received.
-When the credit spreads for a given credit rating and market sector are added to the Treasury spot rates the resulting rate is referred to as the benchmark spot rate curve.
what model is used for valuation of callable bonds
Binomial trees
What is the current yield for a 10-year bond that pays 2% semiannually and is traded at its par
2%
what assumptions are needed for an investor to realize the yield to maturity stated at the time of purchase
the bond is held to maturity
the coupon payments can be reinvested at the yield to maturity
Holding maturity and yield to maturity constant bonds selling at a premium will
be more dependent on reinvestment income than bonds selling at par.
Holding maturity and yield to maturity constant, a bond selling at a discount will
be less dependent on reinvestment income than a bond selling at par.
For a given yield to maturity and a given non-zero coupon rate, the longer the maturity,
the greater the reinvestment risk
Suppose for 10-year non-callable bond has a YTM (yield-to-maturity) of 6.5%, whereas a similar bond which is callable after 4 years has a YTC (yield-to-call) of 8.5%. Which of the two bonds do you recommend to an investor?
it depends on reinvestment rate after 4 years
Option-adjusted spread
used as a spread measure for embedded option risk
what approach is best for measuring the interest rate risk
the duration/convexity approach and the full valuation approach
stress testing
The practice of looking at extreme scenarios to assess exposure to interest rate changes, often done by hedge funds and risk managers
For a given small change in yield, the percentage price change for a given bond is
roughly the same, whether the yield increases or decreases
A callable bond exhibits negative convexity at ______ yield levels and positive convexity at ______ yield levels.
low, high
In large changes, when the yield is increased duration __________ what the new price will be, and when it is decreased duration __________ the new price.
underestimates, underestimates
modified duration
The approximate percentage change in a bond's price for a 100 basis point change in yield assuming that the bond's expected cash flows do not change when the yield changes
The higher the coupon, the ______ the duration and the higher the yield level, the _______ the duration.
lower, lower
When using an issuer-specific interest rate benchmark, OAS reflects the
Liquidity risk
For a callable bond, a higher interest rate volatility assumption causes
-The value of the callable bond to be lower
-The value of the option-free bond not to be affected.
-The value of the call option to increase.
What is the correct order of the following steps for finding changes in a callable/putable bond price for small changes in yield curve when calculating the effective duration?
1. Given the market price of the issue calculate its OAS using the procedure described earlier.
2. Shift the on-the-run yield curve up by a small number of basis points.
3. Construct a binomial interest rate tree based on the new yield curve.
4. To each of the 1-year rates in the binomial interest rate tree, add the OAS to obtain an ''adjusted tree.'' That is, the calculation of the effective duration and convexity assumes that the OAS will not change when interest rates change.
5. Use the adjusted tree found in previous step to determine the value of the bond.
convertible bonds
- Almost all convertible bonds are callable
- Some convertible bonds are potable.
- There are some convertible bonds issues that have a provisional call feature that allows the issuer to call the issue during the non-call period if the price of the stock reaches a certain price.
What is the correct order for the following four investment management activities
1. setting the investment objectives
2. developing and implementing a portfolio strategy
3. monitoring the portfolio
4. adjusting the portfolio
which benchmark that fixed income investors use as their investment objective
Liability structure and Bond market index
Which of the broad-based US bond market indexes the textbook mentions is no longer around and is renamed as "Barclays Capital Aggregate Bond Index"
Lehman Brothers U.S. Aggregate Index
asset-liability mismatch
The risk is that the managed portfolio might not generate sufficient cash flow to satisfy the liability structure
downside risk
Value at risk
Target semivaraince
Shortfall probability
variance of a portfolio
-The expected value for a portfolio is the weighted average of the expected values of the individual bonds in the portfolio.
- The variance of a portfolio of assets depends not only on the variance of each asset, but also on their covariances or correlations.
-Lack of relevant historical data and large number of required estimates are the main two problems associated with using standard deviation as a measure of risk.
tracking error
-If a manager could perfectly match the performance of the portfolio, a tracking error of zero would be realized
-Tracking error measures the dispersion between a portfolio's returns and the returns of a benchmark index.
-An actively managed portfolio that takes positions substantially different from those of the benchmark index would have a large observed tracking error.
optionality risk
-The adverse effect of embedded options on performance is referred to as optionality risk.
- The optionality risk exposure of a bond occurs because a change in interest rates changes the value of the embedded option.
- Optionality risk can be quantified using measures commonly used in the option pricing, delta.
multi-factor risk model
-Multi-factor risk models are used to quantify the risk exposure of a portfolio or a benchmark index.
-A portfolio's risk can be decomposed into two general categories—systematic risk and non-systematic risk.
-Non-systematic risks include issue specific risks as well as issuer's specific factors.
spread duration
-The spread duration for the Treasury sector is zero.
-Zero-volatility spread duration is the percentage change in price for 100 bps shift in spread holding the Treasury spot rate curve fixed.
- For option-adjusted spread duration of 5, if the OAS changes by 20 basis points, then the price of this corporate bond will change by approximately 1%.
- Nominal spread duration is the same as the duration of a bond.
indexing
-A manager might believe that she does not have the skills necessary to outperform a sector of the market.
-Empirical evidence suggests that historically the overall performance of active bond managers has been poor.
-Management advisory and non-advisory fees for indexing are lower compared to active management.
example of strategic strategy for active management
-duration strategies
-inter- and intra-sector allocation strategies
-yield curve strategies
Because a barbell portfolio has ______ convexity than a bullet, it will have a superior performance when the interest rate volatility is _____ .
higher, higher
When using an optimization algorithm to minimize the tracking error (TE) of a portfolio by swapping bond issues
-At each stage the algorithm finds the bond swap with greatest reduction in TE
-The objective specified for the optimizer is to minimize tracking error, subject to keeping the turnover of the portfolio to a minimum.
To perform management performance attribution analysis, Global Advanced Technology decomposes the portfolio return to the all the following categories
-Duration and convexity related return
-Spread change return
-Zero volatility return
leveraging strategies
-The main feature of leveraging is that it magnifies the loss and return realized from investment in a security for a given change in the price of that security.
-Leveraging is the investment approach of borrowing funds with the expectation of earning a return in excess of the cost of funds.
-In a leveraging strategy, the purchased security may be used as collateral for borrowing.
repurchase agreements
-A repurchase agreement is the sale of a security with a commitment by the seller to buy back the same security from the purchaser at a specified price at a designated future date.
-A repurchase agreement is a collateralized loan, where the collateral is the security that is sold and subsequently repurchased.
- dollar interest = amount borrowed × repo rate × repo term/360
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