Deck 12: Bonds: Analysis and Strategy

Question 1

Bond investors can avoid the risk that interest rates will rise and drive bond prices down by:

A) buying stripped bonds.
B) buying Government of Canada bonds.
C) holding intermediate term bonds.
D) holding the bond until maturity.

Answer 1

holding the bond until maturity.

Question 2

Which of the following is not a reason Canadian investors invest in foreign bonds?

A) To access the 98% of fixed-income investment that are issued outside of Canada
B) Foreign bonds may offer higher returns than alternative domestic bonds
C) Foreign bonds have lower transactions costs and are tax exempt
D) Increased diversification potential given the small size of the Canadian bond market

Answer 2

Foreign bonds have lower transactions costs and are tax exempt

Question 3

Which of the following factors has usually had the greatest impact on changes in bond yields?

A) economic growth and expansion/contraction in the economy
B) the position on the economy in various phases of the business cycle
C) changes in the CPI
D) Bank of Canada's interventions via moral suasion

Answer 3

changes in the CPI

Question 4

The term structure of interest rates refers to the relationship:

A) that holds time to maturity constant for a particular class of bonds but examines that relationship at successive intervals.
B) that holds time to maturity constant but allows yields to vary for different categories of bonds at a particular time.
C) between time to maturity and yields for differing categories of bonds at a particular time.
D) between time to maturity and yields for a particular category of bonds at a particular time.

Question 5

Under the Expectations Theory, the assumption is that:

A) expected future rates are equal to implied forward rates.
B) expected future rates exceed implied forward rates.
C) expected future rates are less than implied forward rates.
D) does not purpose a relationship between future rate and an implied forward rate.

Question 6

Which of the following yield curve theories expect investors to stay in one maturity segment, regardless of opportunities in other maturity segments?

A) expectations theory
B) liquidity preference theory
C) market segmentation theory
D) preferred habitat theory

Question 7

The yield curve most likely witnessed in the financial markets is a (an)

A) upward sloping yield curve.
B) downward sloping yield curve.
C) flat yield curve.
D) skewed yield curve.

Question 8

An inverted yield curve or flattening of the yield curve is considered a good predictor of a (an):

A) rapidly expanding economy.
B) economic slowdown or contraction.
C) continuation of existing economic conditions.
D) anticipated major correction in the stock market.

Question 9

Which of the following is not a reason for yield spreads to occur?

A) The two bonds had differences in their call features.
B) The two bonds pay difference coupon rates of interest.
C) The two bonds have different maturities.
D) The two bonds have different bond ratings.

Question 10

Junk bonds have all of the following characteristics except:

A) high risk and high promised yield.
B) low bond rating.
C) interest is paid only when the company can afford it.
D) are usually debentures as opposed to being a mortgage bond.

Question 11

Passive bond strategies include all of the following attributes except:

A) They are based on the proposition that bond prices are fairly determined leaving risk as the variable to control.
B) Once the bonds were purchased investors do nothing accepting changes in market conditions, securities and do on.
C) They are largely based on a buy-and-hold strategy.
D) They follow other bond portfolios and are an example of an indexing strategy.

Question 12

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

A) buying and holding bonds.
B) using horizon analysis.
C) duration matching.
D) indexing the portfolio.

Question 13

Bond swaps involve all of the following steps except:

A) taking advantage of temporary mispricings in the bond market.
B) purchasing and selling bonds.
C) attempting to improve the rate of return on the bond portfolio.
D) reducing the risk by undertaking the swap.

Question 14

Which of the following bond strategies involves no expectations about market changes but involves selling a lower yield bond in order to purchase a higher yielding bond of the same quality and maturity to obtain the higher yield?

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

Question 15

According to the Expectations Theory, long-term rates must:

A) equal the present value of the expected cashflows from the bonds involved.
B) equal the geometric mean of a series of expected future short-term rates.
C) always be higher than short-term rates.
D) be an average of the present and future short-term rates.

Question 16

The yield curve is normally plotted using Bank of Canada 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 17

Which of the theories used to explain the shape of the yield curve in most similar to the market segmentation theory?

A) expectations theory
B) liquidity preference theory
C) preferred habitat theory
D) pecking order theory

Question 18

A major difference between the liquidity preference theory and the expectations theory is that the liquidity preference theory:

A) only deals in short-term securities.
B) recognizes that interest rate expectations are uncertain.
C) only deals in long-term securities.
D) assumes investors are risk averse and the expectations theory does not.

Question 19

Under the Expectations Theory, long term rates:

A) are the summation of short term rates.
B) are the average of present and future short term rates.
C) biased toward the highest prevailing short term rate.
D) biased toward the lowest prevailing short term rate.

Question 20

For portfolio managers attempting to immunize their bond portfolios, they would need to realize that if interest rates were to increase:

A) reinvestment rates increase and bond prices rise.
B) reinvestment rates increase whereas bond prices decline.
C) reinvestment rates decrease whereas bond prices increase.
D) reinvestment rates decrease whereas bond prices decline.

Question 21

A narrowing of the credit spread in the bond market usually indicates:

A) buying of short-term bonds and selling of long-term bonds.
B) buying of long-term bonds and selling of short-term bonds.
C) buying of high-interest bearing bonds.
D) buying of Government of Canada bonds and selling of corporate bonds.

Question 22

Which of the following statements regarding bonds is false?

A) Longer maturities investors to greater interest rate risk.
B) Longer maturities have greater price fluctuations than short term maturities.
C) Shorter maturities are more liquid than longer maturities.
D) Longer maturities have a less chance for larger gains when interest rates decrease.

Question 23

Interest rate swaps involve a contract between two parties who agree to:

A) exchange the bonds but keep the interest payments
B) exchange the interest payments but keep the bonds .
C) exchange both the interest payments and the bonds.
D) have an option to acquire either the interest payments or the bonds.

Question 24

Forward rates:

A) are an average of current short-term and long-term rates.
B) are observable and anticipated.
C) are a component of the market rate for any period.
D) are all of these.

Question 25

Which term structure theory states that investors will not invest long term unless they have an economic incentive.

A) expectations theory
B) liquidity preference theory
C) market segmentation theory
D) preferred habitat theory

Question 26

For conservative investors who invest in Government of Canada Bonds, all of the following risk factors should be considered when forming a bond portfolio, except:

A) interest rate risk.
B) reinvestment rate risk.
C) duration of portfolio.
D) credit risk.

Question 27

The promised yield on a bond is known at the time of purchase.

Question 28

Speculation in the bond market has decreased significantly in the last 20 years.

Question 29

An increase in expected inflation tends to increase bond prices.

Question 30

A stronger dollar decreases the value of dollar-denominated assets to foreign investors.

Question 31

The term structure of interest rates shows the relationship between yields of several risk categories of bonds.

Question 32

In the bond market, a "flight to safety" is usually characterized by an increased demand for high coupon bonds.

Question 33

A strong argument made for passive bond strategies is that it is very difficult to time bond transactions in order to take advantage of swings in the bond market.

Question 34

What are the two components of interest-rate risk? How can portfolio managers use them to attempt to immunize a portfolio?

Question 35

Briefly explain the four theories explaining the term structure of interest rates.

Question 36

A client tells you that he strongly believes that interest rates in general 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?

Question 37

If an investor has an investment horizon of 7 years, how long will be the average duration and maturities of the bonds in his/her portfolio?

Question 38

Why is the duration of a zero-coupon bond always equal to the term of the bond?

Question 39

Modified duration can be used to predict bond price changes in response to small changes in yield. What role does convexity play?

Question 40

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

Question 41

What theoretical problem with duration becomes a real-life problem with immunized portfolios that are subjected to wide swings in interest rates?

Question 42

A 10 per cent, five-year coupon bond with a duration of 4.17 years is selling at par ($1000).
(a) If the market rate drops to 9.5 per cent, what should the new price be?
(b) How will reinvestment income be affected?