Question 1

a manufacturing company receives a ratings upgrade and the price increases on its fixed- rate bond. The price increase was most likely caused by a(n):

Accepted Answer

A ratings upgrade indicates lower credit risk, which leads to a decrease in the bond's credit spread (the additional compensation investors demand for taking on credit risk). As the credit spread decreases, the bond's price increases. Increases in liquidity spread (the additional compensation investors demand for the bond's lack of liquidity) and underlying benchmark rates would not lead to a price increase on a fixed-rate bond.

Question 2

The holding period for a bond at which the coupon reinvestment risk offsets the market price risk is best approximated by:

Accepted Answer

Macaulay duration is the measure of a bond's sensitivity to changes in interest rates and the average time to receive payments. The reinvestment risk occurs when coupon payments received cannot be reinvested at the same rate as the bond's yield to maturity. The Macaulay duration takes into account the timing and amount of all cash flows and provides a measure of the time required to recoup the bond's price. Therefore, the holding period for a bond at which the coupon reinvestment risk offsets the market price risk is best approximated by Macaulay duration.

Question 3

Which of the following statements relating to yield volatility is most accurate? if the term structure of yield volatility is downward sloping, then:

Accepted Answer

When the term structure of yield volatility is downward sloping, it implies that market participants expect short-term rates to be more volatile than long-term rates. This is because changes in short-term rates are typically impacted more by changes in monetary policy and economic conditions, while long-term rates are influenced more by inflation expectations and other structural factors. Therefore, long-term yields are expected to be more stable than short-term yields. However, it does not necessarily mean that short-term bonds will always experience greater price fluctuation than long-term bonds, as other factors such as credit risk and liquidity can also affect bond prices.

Question 4

an investor purchases an annual coupon bond with a 6% coupon rate and exactly 20 years remaining until maturity at a price equal to par value. The investor's investment horizon is Eight years. The approximate modified duration of the bond is 11.470 years. The duration Gap at the time of purchase is closest to:

Accepted Answer

The duration gap is calculated as the difference between the investment horizon and the bond's modified duration. In this case, it's 8 years (investment horizon) - 11.470 years (modified duration) = -3.470 years. However, the correct calculation should result in a negative value, indicating the duration gap. The provided options seem to contain a mistake as none directly match the calculated value. The closest correct approach to finding a duration gap would be subtracting the investment horizon from the modified duration, but the options given do not accurately reflect this calculation based on the information provided. Given the context, option C seems to be an attempt to reflect a duration gap, but the calculation provided in the explanation does not directly match any of the options accurately.

Question 5

a bond has an annual modified duration of 7.020 and annual convexity of 65.180. if the bond's yield-to-maturity decreases by 25 basis points, the expected percentage price Change is closest to:

Accepted Answer

The expected percentage price change of a bond due to a change in yield can be estimated using the formula: $\Delta P/P \approx -D_{mod} \times \Delta y + \frac{1}{2} \times Convexity \times (\Delta y)^2$, where $\Delta P/P$ is the percentage change in price, $D_{mod}$ is the modified duration, $\Delta y$ is the change in yield (in decimal form), and Convexity is the bond's convexity measure. Given that the modified duration is 7.020, the convexity is 65.180, and the yield decreases by 25 basis points (or 0.25%), the change in yield in decimal form is -0.0025. Plugging these values into the formula gives:$\Delta P/P \approx -7.020 \times (-0.0025) + \frac{1}{2} \times 65.180 \times (-0.0025)^2$$\Delta P/P \approx 0.01755 + \frac{1}{2} \times 65.180 \times 0.00000625$$\Delta P/P \approx 0.01755 + 0.000204$$\Delta P/P \approx 0.017754$This is approximately 1.78%.

Question 6

a bond has an annual modified duration of 7.140 and annual convexity of 66.200. The bond's yield-to-maturity is expected to increase by 50 basis points. The expected percent-Age price change is closest to:

Accepted Answer

Using the formula for approximating the percentage price change due to a change in yield-to-maturity:

ΔP/P ≈ -MD*ΔY + 0.5*C*(ΔY)^2

where ΔY is the change in yield-to-maturity, MD is the modified duration, and C is the convexity.

Plugging in the values:

ΔP/P ≈ -7.140*(0.005) + 0.5*66.200*(0.005)^2

ΔP/P ≈ -0.0357 or -3.57%

Therefore, the expected percentage price change is closest to option B (-3.49%).

Question 7

When the investor's investment horizon is less than the Macaulay duration of the bond she owns:

Accepted Answer

When the investment horizon is less than the Macaulay duration, market price risk dominates because the bond's price is more sensitive to interest rate changes, and the investor is at risk of higher rates leading to a decrease in the bond's price.

Quiz 5: Understanding Fixed Income Risk and Return

a manufacturing company receives a ratings upgrade and the price increases on its fixed- rate bond. The price increase was most likely caused by a(n) :

The holding period for a bond at which the coupon reinvestment risk offsets the market price risk is best approximated by:

Which of the following statements relating to yield volatility is most accurate? if the term structure of yield volatility is downward sloping, then:

a bond has an annual modified duration of 7.020 and annual convexity of 65.180. if the bond's yield-to-maturity decreases by 25 basis points, the expected percentage price Change is closest to:

a bond has an annual modified duration of 7.140 and annual convexity of 66.200. The bond's yield-to-maturity is expected to increase by 50 basis points. The expected percent-Age price change is closest to:

When the investor's investment horizon is less than the Macaulay duration of the bond she owns: