Deck 11: Managing Bond Portfolios

Question 1

You find a 5 year AA Xerox bond priced to yield 6%.You find a similar risk 5 year Canon bond priced to yield 6.5%.To take advantage of this you should do which of the following?

A) Short the Canon bond and buy the Xerox bond
B) Buy the Canon bond and short the Xerox bond
C) Short both the Canon bond and the Xerox bond
D) Buy both the Canon bond and the Xerox bond

Answer 1

B

Question 2

As a result of bond convexity an increase in a bond's price when yield to maturity falls is ________ the price decrease resulting from an increase in yield of equal magnitude.

A) greater than
B) equivalent to
C) smaller than
D) The answer is indeterminate.

Answer 2

A

Question 3

All else equal,bond price volatility is greater for __________.

A) higher coupon rates
B) lower coupon rates
C) shorter maturity
D) lower default risk

Answer 3

B

Question 4

A pension fund must pay out $1 million next year,$2 million the following year and then $3 million the year after that.If the discount rate is 8% what is the duration of this set of payments?

A) 2.00 years
B) 2.15 years
C) 2.29 years
D) 2.53 years

Question 5

Target date immunization would primarily be of interest to _________.

A) banks
B) mutual funds
C) pension funds
D) individual investors

Question 6

A forecast of bond returns based largely on a prediction of the yield curve at the end of the investment horizon is called a _________.

A) contingent immunization
B) dedication strategy
C) duration analysis
D) horizon analysis

Question 7

Duration is a concept that is useful in assessing a bond's _________.

A) credit risk
B) liquidity risk
C) price volatility
D) convexity risk

Question 8

A pension fund has an average duration of its liabilities equal to 15 years.The fund is looking at 5 year maturity zero coupon bonds and 4% yield perpetuities to immunize its interest rate risk.How much of its portfolio should it allocate to the zero coupon bonds to immunize if there are no other assets funding the plan?

A) 52%
B) 48%
C) 33%
D) 25%

Question 9

A portfolio manager believes interest rates will drop and decides to sell short duration bonds and buy long duration bonds.This is an example of __________ swap.

A) a pure yield pick up
B) a rate anticipation
C) a substitution
D) an inter-market spread

Question 10

A bond's price volatility _________ at a/an _________ rate as maturity increases.

A) increases; increasing
B) increases; decreasing
C) decreases; increasing
D) decreases; decreasing

Question 11

All other things equal,which of the following has the longest duration?

A) A 21 year bond with a 10% coupon yielding 10%
B) A 20 year bond with a 10% coupon yielding 11%
C) A 21 year zero coupon bond yielding 10%
D) A 20 year zero coupon bond yielding 11%

Question 12

The duration of a perpetuity varies _______ with interest rates.

A) directly
B) inversely
C) convexly
D) randomly

Question 13

______________ is an important characteristic of the relationship between bond prices and yields.

A) Convexity
B) Concavity
C) Complexity
D) Linearity

Question 14

A portfolio manager sells treasury bonds and buys corporate bonds because the spread between corporate and Treasury bond yields is higher than its historical average.This is an example of __________ swap.

A) a pure yield pick up
B) a rate anticipation
C) a substitution
D) an intermarket spread

Question 15

Because of convexity,when interest rates change the actual bond price will ____________ the bond price predicted by duration.

A) always be higher than
B) sometimes be higher than
C) always be lower than
D) sometimes be lower than

Question 16

Bond prices are _______ sensitive to changes in yield when the bond is selling at a _______ initial yield to maturity.

A) more; lower
B) more; higher
C) less; lower
D) equally; higher or lower

Question 17

The pioneer of the duration concept was _________.

A) Eugene Fama
B) John Herzog
C) Frederick Macaulay
D) Harry Markowitz

Question 18

All other things equal,which of the following has the shortest duration?

A) A 30 year bond with a 10% coupon
B) A 20 year bond with a 9% coupon
C) A 20 year bond with a 7% coupon
D) A 10 year zero coupon bond

Question 19

The duration of a 5-year zero coupon bond is ____ years.

A) 4.5
B) 5.0
C) 5.5
D) 3.5

Question 20

All other things equal,which of the following has the longest duration?

A) A 30 year bond with a 10% coupon
B) A 20 year bond with a 9% coupon
C) A 20 year bond with a 7% coupon
D) A 10 year zero coupon bond

Question 21

An increase in a bond's yield to maturity results in a price decline that is ________ the price increase resulting from a decrease in yield of equal magnitude.

A) greater than
B) equivalent to
C) smaller than
D) The answer is indeterminate

Question 22

A bond swap made in response to forecasts of interest rate changes is called ______.

A) a substitution swap
B) an intermarket spread swap
C) rate anticipation swap
D) pure yield pickup swap

Question 23

All other things equal,a bond's duration is _________.

A) higher when the yield to maturity is higher
B) lower when the yield to maturity is higher
C) the same at all yield rates
D) indeterminable when the yield to maturity is high

Question 24

Pension fund managers can generally best bring about an effective reduction in their interest rate risk by holding ___________________.

A) long maturity bonds
B) long duration bonds
C) short maturity bonds
D) short duration bonds

Question 25

The exchange of one bond for a bond with similar attributes but more attractively priced is called ______________.

A) a substitution swap
B) an intermarket spread swap
C) rate anticipation swap
D) pure yield pickup swap

Question 26

A bank has an average duration of its liabilities equal to 2 years.The bank's average duration of its assets is 3.5 years.The bank's market value of equity is at risk if _______________________.

A) interest rates fall
B) credit spreads fall
C) interest rates rise
D) the price of all fixed income securities rises

Question 27

In the context of a bond portfolio,price risk and reinvestment rate risk exactly cancel out at a time horizon equal to ____.

A) the average bond maturity in the portfolio
B) the duration of the portfolio
C) the difference between the shortest duration and longest duration of the individual bonds in the portfolio
D) the average of the shortest duration and longest duration of the bonds in the portfolio

Question 28

You have purchased a Guaranteed Investment contracts (GICs)from an insurance firm that promises to pay you a 5% compound rate of return per year for 6 years.If you pay $10,000 for the GIC today and receive no interest along the way you will get __________ in 6 years (to the nearest dollar).

A) $12,565
B) $13,000
C) $13,401
D) $13,676

Question 29

You own a bond that has a duration of 6 years.Interest rates are currently 7% but you believe the Fed is about to increase interest rates by 25 basis points.Your predicted price change on this bond is ________.

A) +1.40%
B) -1.40%
C) -2.51%
D) +2.51%

Question 30

Given its time to maturity the duration of a zero coupon bond is _________.

A) higher when the discount rate is higher
B) higher when the discount rate is lower
C) lowest when the discount rate is equal to the risk free rate
D) the same regardless of the discount rate

Question 31

Which of the following is not a type of bond swap used in active portfolio management?

A) Inter-market spread swap
B) Substitution swap
C) Rate anticipation swap
D) Asset-liability swap

Question 32

Rank the interest sensitivity of the following from most sensitive to an interest rate change to the least sensitive.
I)8% coupon,noncallable 20 year maturity,par bond
II)9% coupon,currently callable 20 year maturity,premium bond
III)Zero coupon,30 year maturity bond

A) I, II, III
B) II, III, I
C) III, I, II
D) III, II, I

Question 33

The duration rule always ________ the value of a bond following a change in its yield.

A) under-estimates
B) provides an unbiased estimate of
C) over-estimates
D) The estimated price may be biased either upward or downward, depending on whether the bond is trading at a discount or a premium

Question 34

Banks and other financial institutions can best manage interest rate risk by _____________.

A) maximizing the duration of assets and minimizing the duration of liabilities
B) minimizing the duration of assets and maximizing the duration of liabilities
C) matching the durations of their assets and liabilities
D) matching the maturities of their assets and liabilities

Question 35

All other things equal,a bond's duration is _________.

A) higher when the coupon rate is higher
B) lower when the coupon rate is higher
C) the same when the coupon rate is higher
D) indeterminate when the coupon rate is high

Question 36

Bond portfolio immunization techniques balance ________ and ________ risk.

A) price; reinvestment
B) price; liquidity
C) credit; reinvestment
D) credit; liquidity

Question 37

In a pure yield pickup swap,________ bonds are exchanged for _________ bonds.

A) longer duration; shorter duration
B) shorter duration; longer duration
C) high coupon; high yield
D) low yield; high yield

Question 38

Where Y = yield to maturity,the duration of a perpetuity would be _________.

A) Y
B) Y/(1 + Y)
C) 1/Y
D) (1 + Y)/Y

Question 39

The duration of a portfolio of bonds can be calculated as _______________.

A) the coupon weighted average of the durations of the individual bonds in the portfolio
B) the yield weighted average of the durations of the individual bonds in the portfolio
C) the value weighed average of the durations of the individual bonds in the portfolio
D) averages of the durations of the longest and shortest duration bonds in the portfolio

Question 40

Moving to higher yield bonds,usually with longer maturities is called ________.

A) a substitution swap
B) an intermarket spread swap
C) rate anticipation swap
D) pure yield pickup swap

Question 41

When interest rates increase,the duration of a 20-year bond selling at a premium _________.

A) increases
B) decreases
C) remains the same
D) increases at first, then declines

Question 42

Compute the modified duration of a 9% coupon,3-year corporate bond with a yield to maturity of 12%.

A) 2.45
B) 2.75
C) 2.88
D) 3.00

Question 43

A bond currently has a price of $1,050.The yield on the bond is 6.00%.If the yield increases 25 basis points,the price of the bond will go down to $1,030.The duration of this bond is ____ years.

A) 7.46
B) 8.08
C) 9.02
D) 10.11

Question 44

A 20-year maturity bond pays interest of $90 once per year and has a face value of $1,000.Its yield to maturity is 10%.Over the upcoming year,you expect interest rates to decline and that the yield to maturity on this bond will only be 8% a year from now.Using horizon analysis,the return you expect to earn by holding this bond over the upcoming year is _________.

A) 10.0%
B) 12.0%
C) 21.6%
D) 29.6%

Question 45

Duration facilitates the comparison of bonds with differing ___________.

A) default risk
B) conversion ratios
C) maturities
D) yields to maturity

Question 46

A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures in four years. Its yield to maturity is currently 6%.
The duration of this bond is _______ years.

A) 2.44
B) 3.23
C) 3.56
D) 4.10

Question 47

A fixed income portfolio manager sets a minimum acceptable rate of return on the bond portfolio at 5% per year over the next 4 years.The portfolio is currently worth $10 million.One year later interest rates are at 6%.What is the portfolio value trigger point at this time that would require him to immunize the portfolio?

A) $12,155,063
B) $10,205,625
C) $9,627,948
D) $10,500,000

Question 48

Compute the duration of an 8%,5-year corporate bond with a par value of $1000 if yield to maturity of 10%.

A) 3.92
B) 4.28
C) 4.55
D) 5.00

Question 49

A bond has a current price of $1,030.The yield on the bond is 8.00%.If the yield changes from 8.00% to 8.10%,the price of the bond will go down to $1,025.88.The modified duration of this bond is _________.

A) 4.32
B) 4.00
C) 3.25
D) 3.75

Question 50

To create a portfolio with a duration of 4 years using a 5 year zero-coupon bond and a 3 year 8% annual coupon bond with a yield to maturity of 10%,one would have to invest ________ of the portfolio value in the zero-coupon bond.

A) 50%
B) 55%
C) 60%
D) 75%

Question 51

A bond has a maturity of 12 years,a duration of 9.5 years at a promised yield rate of 8%.What is the bond's modified duration?

A) 12 years
B) 11.1 years
C) 9.5 years
D) 8.8 years

Question 52

The duration of a bond normally increases with an increase in _________.
I)term-to-maturity
II)yield-to-maturity.
III)coupon rate

A) I only
B) I and II only
C) II and III only
D) I, II and III

Question 53

A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures in four years. Its yield to maturity is currently 6%.
The modified duration of this bond is ______ years.

A) 4.00
B) 3.56
C) 3.36
D) 3.05

Question 54

An investor who expects declining interest rates would maximize their capital gain by purchasing a bond that has a ___ coupon and a ___ term to maturity.

A) low; long
B) high; short
C) high; long
D) zero; long

Question 55

A perpetuity pays $100 each and every year forever.The duration of this perpetuity will be __________ if its yield is 9%.

A) 7
B) 9
C) 9.39
D) 12.11

Question 56

An 8%,30-year bond has a yield-to-maturity of 10% and a modified duration of 8.0 years.If the market yield drops by 15 basis points,there will be a __________ in the bond's price.

A) 1.15% decrease
B) 1.20% increase
C) 1.53% increase
D) 2.43% decrease

Question 57

Which of the following set of conditions will result in a bond with the greatest price volatility?

A) A high coupon and a short maturity.
B) A high coupon and a long maturity.
C) A low coupon and a short maturity.
D) A low coupon and a long maturity.

Question 58

A bond with a 9-year duration is worth $1,080.00 and its yield to maturity is 8%.If the yield to maturity falls to 7.84%,you would predict that the new value of the bond will be _________.

A) $1,035
B) $1,036
C) $1,094
D) $1,124

Question 59

A bank has $50 million in assets,$47 million in liabilities and $3 million in shareholders' equity.If the duration of its liabilities are 1.3 and the bank wants to immunize its net worth against interest rate risk and thus set the duration of equity equal to zero,it should select assets with an average duration of _________.

A) 1.22
B) 1.50
C) 1.60
D) 2.00

Question 60

The historical yield spread between the AA bond and the AAA bond has been 25 basis points.Currently the spread is only 9 basis points.If you believe the spread will soon return to its historical levels you should ________________________.

A) buy the AA and short the AAA
B) buy both the AA and the AAA
C) buy the AAA and short the AA
D) short both the AA and the AAA

Question 61

If you choose a zero coupon bond with a maturity that matches your investment horizon which of the following statements is/are correct?
I)You will have no interest rate risk on this bond.
II)Absent default,you can be sure you will earn the promised yield rate.
III)The duration of your bond is less than the time to your investment horizon.

A) I only
B) I and II only
C) II and III only
D) I, II and III

Question 62

As compared with equivalent maturity bonds selling at par,deep discount bonds will have ________.

A) greater reinvestment risk
B) greater price volatility
C) less call protection
D) shorter average maturity

Question 63

The duration is independent of the coupon rate only for which one of the following?

A) Discount bonds
B) Premium bonds
C) Perpetuities
D) Short term bonds

Question 64

Steel Pier Company has issued bonds that pay semiannually with the following characteristics:
If the bond's coupon was smaller than 10%,the modified duration would be _____ compared to the original modified duration.

A) larger
B) unchanged
C) smaller
D) There is not enough information to determine the direction of change

Question 65

What strategy might an insurance company employ to ensure that it will be able to meet the obligations of annuity holders?

A) Cash flow matching
B) Index tracking
C) Yield pickup swaps
D) Substitution swap

Question 66

Immunization of coupon paying bonds is not a passive strategy because
I)the portfolio must be rebalanced every time interest rates change
II)the portfolio must be rebalanced over time even if interest rates don't change
III)convexity implies duration based immunization strategies don't work

A) I only
B) I and II only
C) II only
D) I, II and III

Question 67

You have an investment horizon of 6 years.You choose to hold a bond with a duration of 6 years and continue to match your investment horizon and duration throughout your holding period.Your realized rate of return will be the same as the promised yield on the bond if
I)interest rates increase
II)interest rates stay the same
III)interest rates fall

A) I only
B) II only
C) I and II only
D) I, II and III

Question 68

A 20 year maturity corporate bond has a 6.5% coupon rate (the coupons are paid annually).The bond currently sells for $925.50.A bond market analyst forecasts that in five years yield rates on these bonds will be at 7.0%.You believe that you will be able to reinvest the coupons earned over the next five years at a 6% rate of return.What is your expected annual compound rate of return if you plan on selling the bond in five years?

A) 7.37%
B) 7.56%
C) 8.12%
D) 8.54%

Question 69

When bonds sell above par,what is the relationship of price sensitivity to rising interest rates?

A) Price volatility increases at an increasing rate
B) Price volatility increases at a decreasing rate
C) Price volatility decreases at a decreasing rate
D) Price volatility decreases at an increasing rate

Question 70

Steel Pier Company has issued bonds that pay semiannually with the following characteristics:
If the yield to maturity decreases to 8.045% the expected percentage change in the price of the bond using Macauley's duration would be ____,while the expected percentage change in the price of the bond using modified duration would be ____.

A) 11%, 12%
B) 12%, 11%
C) 12%, 12%
D) 11%, 11%

Question 71

A zero coupon bond is selling at a deep discount price of $430.00.It matures in 13 years.If the yield to maturity of the bond is 6.7%,what is the duration of the bond?

A) 6.7 years
B) 8.0 years
C) 10 years
D) 13 years

Question 72

Steel Pier Company has issued bonds that pay semiannually with the following characteristics:
The modified duration for the Steel Pier bond is ______.

A) 6.15 years
B) 5.95 years
C) 6.49 years
D) 9.09 years

Question 73

You have an investment horizon of 6 years.You choose to hold a bond with a duration of 4 years.Your realized rate of return will be larger than the promised yield on the bond if ___________________.

A) interest rates increase
B) interest rates stay the same
C) interest rates fall
D) one can't tell with the information given

Question 74

Which one of the following statements correctly describes the weights used in the Macaulay duration calculation? The weight in year t is equal to ____________.

A) the dollar amount of the investment received in year t
B) the percentage of the future value of the investment received in year t
C) the present value of the dollar amount of the investment received in year t
D) the percentage of the total present value of the investment received in year t

Question 75

If an investment returns a higher percentage of your money back sooner it will ______.

A) be less price volatile
B) have a higher credit rating
C) be less liquid
D) have a higher modified duration

Question 76

You have an investment that in today's dollars returns 15% of your investment in year 1,12% in year two,9% in year 3 and the remainder in year 4.What is the duration of this investment?

A) 4 years
B) 3.50 years
C) 3.22 years
D) 2.95 years

Question 77

Steel Pier Company has issued bonds that pay semiannually with the following characteristics:
If the maturity of the bond was less than 10 years,the modified duration would be _____ compared to the original modified duration.

A) larger
B) unchanged
C) smaller
D) There is not enough information to determine the direction of change

Question 78

Market economists all predict a rise in interest rates.An astute bond manager wishing to maximize her capital gain might employ which strategy?

A) Switch from low duration to high duration bonds.
B) Switch from high duration to low duration bonds.
C) Switch from high grade to low grade bonds.
D) Switch from low coupon to high coupon bonds.

Question 79

You have an investment horizon of 6 years.You choose to hold a bond with a duration of 10 years.Your realized rate of return will be larger than the promised yield on the bond if ___________________.

A) interest rates increase
B) interest rates stay the same
C) interest rates fall
D) one can't tell with the information given

Question 80

A bond portfolio manager notices a hump in the yield curve at the five year point.How might a bond manager take advantage of this event?

A) Buy the 5 year bonds and short the surrounding maturity bonds
B) Buy the 5 year bonds and buy the surrounding maturity bonds
C) Short the 5 year bonds and short the surrounding maturity bonds
D) Short the 5 year bonds and buy the surrounding maturity bonds