Deck 11: Managing Bond Portfolios

Question 1

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 pickup
B) a rate anticipation
C) a substitution
D) an intermarket spread

Answer 1

B

Question 2

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

A) 4.5
B) 5
C) 5.5
D) 3.5

Answer 2

B

Question 3

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 cannot be determined from the information given.

Answer 3

A

Question 4

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 5

A bond's price volatility ________ at ________ rate as maturity increases.

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

Question 6

All other things equal (YTM = 10%), 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 7

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

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

Question 8

All other things equal (YTM = 10%), 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 9

Target date immunization would primarily be of interest to ________.

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

Question 10

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 11

The duration of a perpetuity varies ________ with interest rates.

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

Question 12

The pioneer of the duration concept was ________.

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

Question 13

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 14

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 15

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

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

Question 16

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

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

Question 17

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) 52.38%
B) 48.38%
C) 33.58%
D) 25.48%

Question 18

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 pickup
B) a rate anticipation
C) a substitution
D) an intermarket spread

Question 19

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%. If you expect interest rates to rise, which of the following should you do?

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.

Question 20

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

Question 21

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 22

Rank the interest sensitivity of the following from the 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 23

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 weighted 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 24

The exchange of one bond for a bond that has similar attributes but is more attractively priced is called ________.

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

Question 25

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 26

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

A) underestimates
B) provides an unbiased estimate of
C) overestimates
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 27

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) +1.4%
B) -1.4%
C) -2.51%
D) +2.51%

Question 28

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 29

You have purchased a guaranteed investment contract (GIC) 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 30

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) indeterminable when the coupon rate is high

Question 31

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 32

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

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

Question 33

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

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

Question 34

Bond portfolio immunization techniques balance ________ and ________ risk.

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

Question 35

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 36

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 cannot be determined.

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

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 39

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

A) intermarket spread swap
B) substitution swap
C) rate anticipation swap
D) asset-liability swap

Question 40

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

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

Question 41

A bond with a 9-year duration is worth $1,080, 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 approximately ________.

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

Question 42

Duration facilitates the comparison of bonds with differing ________.

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

Question 43

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

Question 44

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

A) 1.15% decrease
B) 1.2% increase
C) 1.53% increase
D) 2.43% decrease

Question 45

An investor who expects declining interest rates would maximize her 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 46

A bond has a maturity of 12 years and 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 47

A bond currently has a price of $1,050. The yield on the bond is 6%. 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 48

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 49

A bond has a current price of $1,030. The yield on the bond is 8%. If the yield changes from 8% to 8.1%, the price of the bond will go down to $1,025.88. The modified duration of this bond is ________.

A) 4.32
B) 4
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 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%. You expect that interest rates will decline over the upcoming year and that the yield to maturity on this bond will be only 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%
B) 12%
C) 21.6%
D) 29.6%

Question 52

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) In the absence of 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 53

A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures in 4 years. Its yield to maturity is currently 6%.
The modified duration of this bond is ________ years.

A) 4
B) 3.56
C) 3.36
D) 3.05

Question 54

A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures in 4 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) 4.1

Question 55

A bank has $50 million in assets, $47 million in liabilities, and $3 million in shareholders' equity. If the duration of its liabilities is 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) 1.5
C) 1.6
D) 2

Question 56

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 57

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 58

Compute the duration of an 8%, 5-year corporate bond with a par value of $1,000 and yield to maturity of 10%.

A) 3.92
B) 4.28
C) 4.55
D) 5

Question 59

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 and then declines

Question 60

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 61

Immunization of coupon-paying bonds does not imply that the portfolio manager is inactive 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 62

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 63

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) The answer cannot be determined from the information given.

Question 64

Advantages of cash flow matching and dedicated strategies include:
I) Once the cash flows are matched, there is no need for rebalancing.
II) Cash flow matching typically earns a higher rate of return than active bond portfolio management.
III) Financial institutions' liabilities often exceed the maturity of available bonds, making cash matching even more desirable.

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

Question 65

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) The answer cannot be determined from the information given.

Question 66

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 modified duration would be ________.

A) 11%
B) 13%
C) 12%
D) 10%

Question 67

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 68

You have an investment that in today's dollars returns 15% of your investment in year 1, 12% in year 2, 9% in year 3, and the remainder in year 4. What is the duration of this investment?

A) 4 years
B) 3.5 years
C) 3.22 years
D) 2.95 years

Question 69

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) The answer cannot be determined from the information given.

Question 70

A zero-coupon bond is selling at a deep discount price of $430. 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 years
C) 10 years
D) 13 years

Question 71

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 72

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 73

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 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

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 5 years yields on such bonds will be at 7%. You believe that you will be able to reinvest the coupons earned over the next 5 years at a 6% rate of return. What is your expected annual compound rate of return if you plan on selling the bond in 5 years?

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

Question 76

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 77

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 78

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 79

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) The answer cannot be determined from the information given.

Question 80

A bond portfolio manager notices a hump in the yield curve at the 5-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.