Deck 15: Fixed-Income Active Management: Credit Strategies

Question 1

to address gerber's tail risk concern, Petit should recommend that expected correlations with their models:

A) decrease.
B) do not change.
C) increase.

Answer 1

C

Question 2

Which reason best supports Petit's recommendation to increase the firm's investment in high-yield bonds?

A) reason 1
B) reason 2
C) reason 3

Answer 2

C

Question 3

What secondary market characteristics would most likely have gerber's desired effect on portfolio liquidity?

A) decreased trading volume
B) less spread sensitivity to fund outflows
C) a decrease in broker/dealer holdings

Answer 3

B

Question 4

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
a benefit of easton's preferred credit spread measure is that it:

A) provides a good measure of credit spread for bonds with optionality.
B) uses swap rates denominated in the same currency as the credit security.
C) reduces the potential for maturity mismatch.

Question 5

Which of gerber's three differences about investing in eM credits compared with devel- oped market credits is most correct?

A) difference 1
B) difference 2
C) difference 3

Question 6

is Petit's prediction correct that the eKn bond price will not change in response to the interest rate and credit spread changes, all else being equal?

A) Yes
B) no, the bond price should decrease.
C) no, the bond price should increase.

Question 7

Which of gerber's statements about international credit management is correct?

A) Statement 1
B) Statement 2
C) Statement 3

Question 8

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
Which of avelyn's statements about the differences between investment-grade and high- yield bonds is accurate?

A) Statement 1
B) Statement 2
C) Statement 3

Question 9

Which of gerber's points about empirical duration is correct?

A) Point 1
B) Point 2
C) Point 3

Question 10

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
Which of easton's statements about the liquidity and trading characteristics of high-yield and investment-grade bonds is most correct?

A) dealers generally hold larger inventories of high-yield bonds than investment-grade bonds.
B) both high-yield and investment-grade bonds are quoted as spreads over benchmark government bonds.
C) The bid-offer spread of high-yield bonds is normally larger than that of invest- ment-grade bonds with similar maturities.

Question 11

Which of Petit's observations about the three bbb rated bonds is most likely correct?

A) observation 1
B) observation 2
C) observation 3

Question 12

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
Which of the following is most likely to be used when selecting securities based on dyna- mo's credit strategy approach?

A) Macro factors
B) expected excess returns
C) average option-adjusted spread

Question 13

based on Petit's expectations for US and european corporate bonds, which of the follow- ing positions relative to the portfolio's benchmark should she recommend?

Question 14

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
Which of avelyn's comments regarding considerations in the bottom-up approach is most accurate?

A) comment 1
B) comment 2
C) comment 3

Question 15

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-
ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, to
discuss the structure and management of this investment portfolio, as well as some possible
changes to the portfolio composition.
easton begins the meeting by stating her belief that the credit spread is the single most
important measure that investors use when selecting bonds. among the various credit spread
measures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-up
approach that selects bonds with the best relative value from the universe of bonds with similar
characteristics. avelyn comments on the following considerations in a bottom-up approach.
comment 1: callable debt has a smaller option-adjusted spread than comparable
non-callable debt.
comment 2: benchmark corporate bond issues normally have wider spreads than older
bonds of the same issuer.
comment 3: The announcement of a new corporate bond issue often leads to an in-
crease in the credit spread on the existing bonds.
dynamo is changing the bond portfolio's investment constraints so that it can invest up to
20% of the assets in high-yield corporate bonds and 20% in structured financial instruments.
easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds,
will be a key consideration in our security selection. although both high-yield and
investment-grade bonds are quoted as spreads over benchmark government bonds,
we must be aware that dealers are likely to hold larger inventories of high-yield bonds
and their bid-offer spreads will be larger.
avelyn makes the following statements about the differences between investment-grade
and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high-
yield bonds tend to perform more like investment-grade bonds.
Statement 2: investment-grade bonds have greater exposure to credit risk than high-
yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-
ment-grade bonds.
two of the structured financial instruments that easton and avelyn are considering for
dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and
avelyn make the following comments about the securities.
easton: if the correlation of the expected defaults on the cdo collateral of the sen-
ior and subordinated tranches is positive, the relative value of the mezzanine
tranche compared with the senior and equity tranches will increase.
avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful
diversification to the investment portfolio.
avelyn: investing in covered bonds will give us the yield increase we are seeking com-
pared with investing in corporate bonds or asset-backed securities.
Which comment regarding cdos and covered bonds is accurate?

A) easton's comment
B) avelyn's first comment
C) avelyn's second comment