Deck 14: Managing Interest Rate Risk

Question 1

In the immunisation process:

A) DGAP is not equal to zero.
B) DGAP > 0.
C) DGAP = 0.
D) DGAP < 0.

Answer 1

C

Question 2

When we will calculate the change in price that occurs when the market yield increases by one basis point, it is known as:

A) convexity.
B) modified duration.
C) YTM.
D) PVBP.

Answer 2

D

Question 3

Suppose you are a bond portfolio manager and you expect interest rates to increase. You will your duration by long- term maturity bonds if you want to manage your risk.

A) increase; buying
B) decrease; selling
C) decrease; buying
D) increase; selling

Answer 3

B

Question 4

The average convexity of a dumbbell portfolio:

A) falls as the coupons increase.
B) cannot be calculated.
C) eventually declines to zero.
D) is higher than that of a matching bullet portfolio.

Question 5

Modified duration is calculated as:

A) duration multiply by convexity.
B) duration divided by 12.
C) duration divided by (1+ interest rate).
D) duration multiply by interest rate.

Question 6

Which of the following statements is correct?

A) The durations of zero- coupon bonds and discount securities are always equal to their terms.
B) The durations of zero- coupon bonds and discount securities are equal to their terms during a financial crisis.
C) The durations of zero- coupon bonds and discount securities are not equal to their terms.
D) The durations of zero- coupon bonds and discount securities are not always equal to their terms.

Question 7

When we improve the accuracy of the approximation by taking account of the curvature of the price-yield curve, the concept is known as:

A) modified duration.
B) DGAP.
C) convexity.
D) PVBP.

Question 8

The sensitivity of the security price to its term.

A) is not related
B) does not go up in proportion
C) increases exponentially
D) goes up in proportion

Question 9

The objective of the corporate risk manager is to:

A) minimise cost of funding.
B) ensure a known cost of funding.
C) maintain zero corporate risk.
D) A and B.

Question 10

Convexity increases as:

A) the market yield falls.
B) the value of the coupon payment falls.
C) the term of the security increases.
D) all of the above.

Question 11

The duration of a coupon bond at a rate as its term .

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

Question 12

The weighted average of the squares of the times to the receipt of cash flows where the weights are the present values of the corresponding elements of the cash flow plus the weighted average of the times to receipt of the cash flows. This is known as the:

A) duration.
B) convexity.
C) DGAP.
D) modified duration.

Question 13

Kirkwood and Idil (2009) noted that, prior to the middle of 2007, approximately of corporate funding was obtained from retained earnings, while the remainder was obtained from banks, debt markets and equity markets.

A) 90%
B) one- third
C) 10%
D) two- thirds

Question 14

Insulating a portfolio from the effects of interest rate changes is known as:

A) immunisation.
B) gapping.
C) sterilisation.
D) duration.

Question 15

Duration as the yield .

A) increases; increases
B) falls ; increases
C) is unchanged; increases
D) falls; falls

Question 16

The sensitivity of a bond's price to a change in interest rates is known as:

A) principal.
B) yield.
C) duration.
D) coupon.

Question 17

As the term of the security increases, the sensitivity of its price to changes in interest rates:

A) cannot be determined due to lack of information.
B) increases.
C) decreases.
D) is unchanged.

Question 18

'Duration' refers to:

A) the period of time remaining in the life of a security until it matures.
B) the maturity of a security.
C) the period of time an investor has held the security.
D) the weighted average of the maturities of the security's cash flows.

Question 19

The convexity (CX) of a ZCB is given by:

A) CX = (Term) squared.
B) CX = (Term) squared + (Term).
C) CX = (Term) × (market yield) squared.
D) CX = (Term) × (market yield).

Question 20

The prices of the securities are more interest rate sensitive in interest rate environments than when interest rates are .

A) low; low
B) low; high
C) high; high
D) none of the above

Question 21

The cover ratio needs to be higher the greater:

A) the volatility of the return on assets.
B) the volatility of interest rates.
C) the leverage of the firm.
D) all of the above.

Question 22

A portfolio is exposed to interest rate increases causing a loss of capital when:

A) the average duration of assets is less than the average duration of liabilities.
B) both ZCBs and annuities are held.
C) the average duration of assets is greater than the average duration of liabilities.
D) neither ZCBs nor annuities are held.

Question 23

Convexity cannot be used to construct a more accurate hedge for a security.

Question 24

A 'bullet portfolio' is one where:

A) two ZCBs are held whose average duration equals a desired benchmark duration.
B) no ZCBs are held.
C) only ZCBs are held whose exact duration equals a desired benchmark duration.
D) none of the above.

Question 25

Modified duration is adjusted for the curvature in the yield curve.

Question 26

A perpetuity (a bond with an infinite life) has a finite duration because after a certain point (depending on the interest rate), cash flows are so heavily discounted that they no longer affect the average.

Question 27

Which of the following is a problem with duration hedges?

A) It is not accurate with large changes in interest rates.
B) The hedge is instantaneous.
C) The position is only immunised against uniform shifts in the yield curve.
D) All of the above.

Question 28

The duration of most securities as the yield changes.

A) does not changes
B) decreases
C) changes
D) increases

Question 29

The convexity of a security increases as:

A) the benchmark rises.
B) the market yield rises.
C) the term to maturity increases.
D) the coupons increase.

Question 30

Which of the following variables is used in the approximation tangent equation?

A) Duration.
B) Fall in interest rate.
C) Interest rate.
D) All of the above.

Question 31

When a portfolio is immunised our net worth will not deteriorate upon a change of interest rates.

Question 32

Marked- to- market implies that assets and liabilities are valued at market prices.

Question 33

The cover ratio is a static measure which shows the situation which prevails at the present time.

Question 34

Duration gaps can be altered with the use of derivatives so that they are equal to zero.

Question 35

When DGAP < 0, DA is below DL. An interest rate fall will cause the asset to increase in value by less than the liability; that is, our net position will deteriorate.

Question 36

When hedging with DGAP, if the yields change by different amounts, the net value of the position will be affected.

Question 37

Duration gap is equal to:

A) DA + DL
B) FV × DA - DL
C) DA - DL
D) DA × DL

Question 38

The 'additive property' of duration says that the average duration of a group of securities is equal to the duration of all the cash flows generated by these securities.

Question 39

Which of the following is a characteristic of a bullet portfolio?

A) Holding zero- coupon bonds with terms and duration equal to the duration of the benchmark.
B) If the interest rates change, the gains and losses on the portfolio will approximately match those of the benchmark.
C) It consists of two zero- coupon bonds with average duration equal to the duration of the benchmark.
D) A and B.

Question 40

The number of futures contracts (N) necessary to close a given DGAP is determined by:

A) total assets.
B) price of bill futures contract.
C) modified duration of futures contract.
D) all of the above.

Question 41

When DGAP = 0, a change in interest rates will have the same dollar value effect on the prices of the asset and liability. Our position is insulated from interest rate movements.

Question 42

Ensuring a known cost of funding is appropriate for active managers.

Question 43

DGAP protects us against uniform changes in yields in the future but not in the near future.

Question 44

The duration of a coupon bond increases at a diminishing rate as its term increases, so that the gap between the duration and term of the bond also widens as the term increases.

Question 45

The duration gap (DGAP) of a portfolio uses current market values of assets and liabilities.

Question 46

When we are dealing with a full portfolio, we need to take account of the presence of capital (equity) in that portfolio and thus have to adjust DGAP.

Question 47

The duration of a coupon bond falls as the yield increases.

Question 48

Convexity also has the additive property possessed by duration.

Question 49

When DGAP > 0, DA must be above DL. An interest rate increase will lead to a fall in the value of both the asset and the liability, but, since it has the higher duration, the price of the asset will fall further; that is, we will lose.

Question 50

Only interest rate futures can be used to immunise portfolios.

Question 51

One problem with duration hedges is that they are only accurate for very small changes in the interest rate.

Question 52

The 'modified duration' of a security refers to the percentage change in the yield when the interest rate changes 1%.

Question 53

If the duration gap is negative, a fall in interest rates will result in a net capital gain on our position.

Question 54

A dumbbell portfolio consists of two zero- coupon bonds with average duration equal to the duration
of the benchmark.

Question 55

There is a trade- off between achieving the lowest possible average cost of borrowing and obtaining certainty about these costs. One of the advantages of derivative instruments is that they can be used to improve the terms of this trade- off.

Question 56

The duration of a zero- coupon bond is constant and is equal to its term regardless of the yield.

Question 57

If we annualised the duration, we end up with the convexity.

Question 58

A position is said to be 'immunised' when a change in interest rates will have a zero- dollar effect on assets and a zero- dollar effect on liabilities.

Question 59

The performance of fund managers is often judged against that of a benchmark portfolio.

Question 60

The error in the approximation increases as the size of the yield change increases because the price- yield curve is convex.

Question 61

Minimising the average cost of funding is a strategy used by active managers.

Question 62

Marked- to- market implies that assets and liabilities are bought and sold on a daily basis.

Question 63

Can derivatives be used to enhance hedging?

Question 64

The 'duration gap' is defined as the duration of the assets in a portfolio minus the duration of the liabilities in a portfolio.

Question 65

A highly leveraged operation will easily meet its interest payments when interest rates rise sharply.

Question 66

An active portfolio manager always immunises his portfolio.

Question 67

If your primary task is to manage the risk of a bond portfolio and the yield curve is upward sloping, how would you achieve your goal by changing the constituents of your portfolio?

Question 68

For fixed- interest funds, that benchmark portfolio will have different durations.

Question 69

An active manager will actually attempt to choose times of refinancing to take advantage of projected future changes in interest rates.

Question 70

Critically discuss the use of duration to hedge against interest rate risk.