Deck 18: Bonds: Analysis and Strategy

Question 1

Which of the following statements about the bond market is not true?

A) Short maturities sacrifice price appreciation opportunities.
B) Longer maturities have greater price fluctuations.
C) Short maturities serve to protect the investor when rates are rising.
D) Long term interest rates are more volatile than short term interest rates.

Answer 1

D

Question 2

Which form of interest rate forecasting involves evaluating bonds to determine which will perform best over a selected holding period?

A) Horizon analysis
B) Yield-to-maturity analysis
C) Yield curve analysis
D) Bond immunization analysis

Answer 2

A

Question 3

The introduction of the Euro:

A) increased the transactions cost of trading foreign bonds.
B) decreased the transactions cost of trading foreign bonds.
C) had no effect on the transactions cost of trading foreign bonds.
D) had a minimal effect on the transactions cost of trading foreign bonds.

Answer 3

B

Question 4

Which of the following would not be expected to cause yield spreads to widen?

A) The firm is involved in an accounting scandal.
B) The firm issues equity to repurchase debt.
C) A financial crisis, such as the 2008 crisis, occurs.
D) The firm is subject to litigation.

Question 5

Which of the following statements is true regarding investments in bonds?

A) Shorter maturity bonds generally return more than longer maturity bonds.
B) Treasury bonds generally return more than corporate bonds of the same maturity.
C) Longer maturity bonds generally return more than shorter maturity bonds.
D) Higher-rated bonds generally return more than lower-rated bonds.

Question 6

Duration is a measure that relates a:

A) bond's price to its time to maturity.
B) bond's price to its coupon rate.
C) bond's yield to maturity to its time to maturity.
D) bond's price to its yield to maturity.

Question 7

The yield on a small, regional corporate bond is generally higher than the yield on a large, national corporate bond mainly due to:

A) differences in coupon rates.
B) differences in quality.
C) differences in tax treatments.
D) differences in marketability.

Question 8

Historically, the yield curve has most often been:

A) upward sloping.
B) downward sloping.
C) flat.
D) bell-shaped.

Question 9

Which of the following is an active bond strategy?

A) Bond swaps
B) Barbell investing
C) Buy-and-hold
D) Ladder investing

Question 10

During periods of economic expansion, the spread between corporate bonds and U.S. Treasuries generally:

A) widens.
B) narrows.
C) stays the same.
D) becomes negative.

Question 11

The term structure of interest rates is also known as the:

A) yield to maturity.
B) probability distribution.
C) yield differential.
D) yield curve.

Question 12

Bond investors expecting interest rates to rise should shift their portfolios toward:
A) longer term bonds.

A) shorter term bonds.
B) higher quality bonds.
C) lower quality bonds.

Question 13

Which of the following statements concerning yield spreads is not true?

A) Yield spreads may be positive or negative.
B) Credit spreads are often calculated across bond maturities.
C) Yield spreads are influenced by the level of interest rates in the market.
D) Credit spreads can change over time.

Question 14

The yield curve is normally plotted using Treasury securities because:

A) they have a wide range of maturities.
B) it is easier to obtain accurate and complete data on them.
C) they have no default risk.
D) it is easier to obtain historical data on them.

Question 15

Which of the following is considered to have the biggest impact on bond yields?

A) Economic growth
B) Business cycles
C) Inflation
D) Federal Reserve actions

Question 16

During recessions, yield spreads tend to:

A) narrow, whereas they generally widen during economic expansions.
B) widen, whereas they generally narrow during economic expansions.
C) narrow and they also generally narrow during economic expansions.
D) widen and they also generally widen during economic expansions.

Question 17

Floating rate bonds often have yields tied to the:

A) London Interbank Offered Rate (LIBOR).
B) Federal Reserve discount rate.
C) European Central Bank (ECB) borrowing rate.
D) Federal Funds overnight lending rate.

Question 18

Regardless of its maturity date, it is very unusual for a coupon-paying bond to have a duration greater than:

A) 2 years.
B) 4 years.
C) 7 years.
D) 10 years.

Question 19

Bond investors can avoid the losses caused by rising interest rates by:

A) buying zero coupon bonds.
B) buying Treasury bonds with maturities of one year or longer.
C) holding bond funds until maturity.
D) holding individual bonds until maturity.

Question 20

Under a laddering approach, investors mitigate the effects of an interest rate increase by:

A) purchasing bonds in two maturity groups, long or short.
B) purchasing bonds with the same maturity date but with a variety of coupon rates.
C) purchasing bonds with a variety of maturity dates.
D) purchasing bonds with a variety of YTMs.

Question 21

Which of the following statements regarding classical immunization is false?

A) It is easy to implement.
B) It requires frequent rebalancing.
C) It is not a passive bond strategy.
D) It faces real-world problems in its implementation.

Question 22

Which of the following 10-year, 8% bonds will offer the highest YTM?

A) AAA-rated, callable bond
B) AAA-rated, non-callable bond
C) BBB-rated, callable bond
D) BBB-rated, non-callable bond

Question 23

James has a 10-year investment horizon. To achieve an immunized position, his bond portfolio will have an average duration that is:

A) greater than 10 years and have an average maturity that is less than 10 years.
B) equal to 10 years and have an average maturity that is less than 10 years.
C) less than 10 years and have an average maturity that is equal to 10 years.
D) equal to 10 years and have an average maturity that is greater than 10 years.

Question 24

Which of the following terms describes a change in investors' preferences away from risky assets towards safer bonds?

A) Immunization
B) Flight to safety
C) Laddering
D) Convexity

Question 25

Buying a bond (for example, with fixed-rate coupon payments) and simultaneously selling another (for example, with variable rate interest payments) is an example of:

A) a bond ladder strategy.
B) a bond swap.
C) an interest rate futures transaction.
D) an immunization strategy.

Question 26

If two coupon bonds are equivalent in all other respects, which will have the higher convexity?

A) The bond with the higher coupon.
B) The bond with the longer maturity.
C) The bond with the greater yield.
D) The bond with the lower credit rating.

Question 27

A bond strategy that attempts to immunize the portfolio from interest rate risk is based on the concept of:

A) buy and hold.
B) horizon analysis.
C) duration.
D) indexing.

Question 28

A coupon bond has 10-years to maturity and a YTM of 8%. If the YTM instantaneously increases to 9%, what happens to the bond's price and duration?

A) The price decreases and the duration increases.
B) The price increases and the duration decreases.
C) The price decreases and the duration decreases.
D) The price decreases and the duration stays the same.

Question 29

Using its modified duration, the price of a coupon bond is forecasted to change from $990 to $925 due to an increase in interest rates. If the bond's convexity is considered, the new forecasted price of the bond will be:

A) higher than $925.
B) lower than $925.
C) equal to $925.
D) Cannot be determined.

Question 30

Relative to actively-managed bond funds, a major advantage of bond index funds is their:

A) higher performance.
B) ability to shelter income from taxes.
C) lower expense ratios.
D) lower duration.

Question 31

A portfolio is said to be immunized if:

A) the present value of its cash flows equals its principal value.
B) the duration of the portfolio is equal to its maturity.
C) the present value of its cash flows is greater than its principal value.
D) the duration of the portfolio is equal to the investor's investment horizon.

Question 32

A bond investor has $100,000 and has determined 5 years is his maximum term. He puts $20,000 in one-year bonds, $20,000 in two-year bonds, etc. up to $20,000 in five-year bonds. This is an example of:

A) a barbell strategy.
B) a laddering strategy.
C) an immunization strategy.
D) a term management strategy.

Question 33

Which of the following is not a passive bond strategy?

A) A barbell strategy
B) A bond swap strategy
C) A buy and hold strategy
D) An indexing strategy

Question 34

Immunization is a strategy in which bond investors:

A) buy only high-quality bonds.
B) attempt to avoid default risk.
C) attempt to avoid call and convertible risk.
D) attempt to avoid reinvestment and price risk.

Question 35

Which form of duration should be used when evaluating a floating-rate bond?

A) Macaulay duration
B) Modified duration
C) Effective duration
D) Convexity duration

Question 36

Interest rate risk is composed of:

A) market risk and default risk.
B) price risk and credit risk.
C) price risk and reinvestment risk.
D) default risk and liquidity risk.

Question 37

For a bond, Macaulay duration represents the time period where:

A) duration equals convexity.
B) reinvestment risk equals price risk.
C) time to maturity equals investment horizon.
D) the coupon rate equals the required return.

Question 38

Which of the following statements regarding the duration of a coupon bond is false?

A) YTM and duration are inversely related.
B) Coupon rate and duration are inversely related.
C) Duration is a weighted average time to recovery of all coupon payments.
D) Duration increases with time to maturity but at a decreasing rate.

Question 39

Which of the following European countries experienced a debt crisis post-2008?

A) Germany
B) Great Britain
C) Greece
D) France

Question 40

A zero-coupon bond has 10-years to maturity and a YTM of 8%. If the YTM instantaneously increases to 9%, what happens to the bond's price and duration?

A) The price decreases and the duration increases.
B) The price increases and the duration decreases.
C) The price decreases and the duration decreases.
D) The price decreases and the duration stays the same.

Question 41

The term structure of interest rates shows the relationship between yields of several categories of bonds, such as municipals and corporates, and their maturities.

Question 42

The credit spread cannot be negative.

Question 43

The interest rate term structure shows the relation between bond return and maturity.

Question 44

Holding maturity constant, a decrease in rates will raise bond prices on a percentage basis more than a corresponding increase in rates will lower bond prices.

Question 45

A weaker dollar increases the value of dollar-denominated assets to foreign investors.

Question 46

A commercial bank that always invests in short-term bonds in order to meet deposit withdrawals is a good example of a firm following the liquidity preference theory.

Question 47

Convexity is used to correct the approximate percentage change in bond value calculated using modified duration.

Question 48

A perpetual bond has an infinite duration.

Question 49

If interest rates rise, reinvestment rates rise, whereas bond prices decline.

Question 50

Yield spreads tend to be highest during periods of economic turmoil.

Question 51

The size of yield spreads tends to remain constant over time.

Question 52

One of the most cost-effective methods of passive bond investing is buying into a bond ETF.

Question 53

A bond investor wishing to take advantage of a forecasted decrease in interest rates would shift toward bonds with lower coupon payments and longer maturities.

Question 54

Under the ladder approach, bond investors purchase bonds with different maturities in order to gain some protection from default risk.

Question 55

For a zero-coupon bond, duration is the same as time to maturity.

Question 56

An investor desiring a bond investment that changes as little as possible as interest rates change should seek a bond with long duration rather than a strip.

Question 57

A noncallable bond would be expected to have a higher yield to maturity than a comparable callable bond.

Question 58

The units of measure for modified duration is years.

Question 59

A bond swap involves the simultaneous selling of one bond and buying another.

Question 60

An increase in expected inflation tends to decrease bond prices.

Question 61

Effective duration should be used to reflect the default risk of a callable bond.

Question 62

Why is immunization considered to be a hybrid strategy?

Question 63

The measured credit spread widens as you move into lower and lower quality bonds i.e., the spread between long-term T-bonds and BBB bonds is higher than the spread between long-term T-bonds and AAA bonds. Where do you generally find the largest increase in the credit spread due to a single step down in credit rating? Explain.

Question 64

A 9% semi-annual RXP callable bond is selling for $1,090 and has 15 years to maturity. The bond has five years of call protection and is callable at 105% of par value. What is the yield to maturity on the bond? What is the bond's yield to first call (YTFC)? What measure should an investor use to represent the interest rate risk of the RXP bond?

Question 65

What are the two components of interest-rate risk? How do they work to immunize a portfolio?

Question 66

A client tells you that he strongly believes that interest rates will fall abruptly over the next six months. He asks you to recommend bonds for a portfolio to provide capital gains on the interest rate move. Generally, what would you suggest? What if he expected rates to rise? How would your answer be impacted if the yield curve has a steep downward slope?

Question 67

What are two passive management strategies? Two active strategies?

Question 68

What are the advantages and disadvantages of index funds for an individual bond investor?

Question 69

You are asked to invest $30 million in a bond portfolio consisting of only two bonds. Bond A has a duration of 4.36 years, and bond B has a duration of 6.50 years. The portfolio is to have an investment horizon of 5 years. How much of each bond issue would you have to buy to immunize the portfolio?

Question 70

A Pfizer bond has a YTM of 7%, it is selling for $980, and its Macaulay duration is 5 years. Assume the required yield increases to 7.4%. What is the new price predicted by modified duration? Is the actual estimated price higher or lower than that predicted by modified duration?

Question 71

Why are upward sloping yield curves more consistent with the usual risk-return tradeoff than downward sloping yield curves?

Question 72

Immunization is intended to protect a portfolio against interest rate risk. What should be done? How does it work?