quiz 7
which of the following does NOT imply a longer duration? higher coupon rate higher maturity lower coupon rate lower yield to maturity
higher coupon rate duration is increased by longer maturity, a lower coupon rate, and a lower yield to maturity. hence, a higher coupon rate does not imply a longer duration.
which of the following is a reason to prefer the effective duration measure over the "typical" duration measure?
includes effect of call / put provisions the effective duration measures the bond's price sensitivity given a range of interest rates, while the "typical" duration measures its price sensitivity at a single point. this is a less precise measure, but it allows us to account for the effects of call / put provisions, as they can be observed over a range - they would be completely ignored when focusing on a single point.
According to our discussion, net worth immunization works by o setting the interest rate risk of our assets with the _________.
interest rate risk of our liabilities A portfolio is immunized by "cancelling out" interest rate risk with other risk. In particular, for net worth immunization, we protect our net worth by ensuring that our assets and liabilities have equal durations. This ensures that they move in the same proportion. Thus, we are o setting our assets' interest rate risk with the interest rate risk of our liabilities.
When implementing a target date immunization strategy, we attempt to offset the _________ risk of our portfolio with its _______ risk.
interest rate; reinvestment target date immunization attempts to protect the future value of our portfolio at the specified investment horizon by offsetting its interest rate risk - the risk that interest rates increase and decrease the value of our bond - with its reinvestment risk - the risk that interest rates decrease and reduce the value of our reinvested coupons.
key rates can be used to resolve which problem with our typical duration calculation?
interest rates don't move in parallel key rates are a way to isolate the particular rate(s) that are important to a bond's interest rate risk and calculate essentially partial duration.
according to our discussion, if interest rates fail to move in parallel we would need to use a(n) _____ duration measure to account for how it affects the bond's price.
key rate there are several forms of duration measures. however, most of them assume a parallel shift in the yield curve. if this assumption is not true, then we must use partial durations. these are known as key rate durations.
all else equal, bonds with ________ are MORE sensitive to interest rate movements.
longer maturities a bond with a longer maturity is more sensitive to interest are changes.
You run a small savings and loan. Much like a bank, you pay interest on your liabilities (deposits) and receive interest on your assets (loans). What strategy might you employ in order to protect the value of the firm?
net worth immunization since both your assets and liabilities are interest rate sensitive, you would want to employ a net worth immunization strategy to ensure that changes to the two offset.
You are managing an investment company that focuses on investing in bonds, annuities, and other interest rate securities. In addition, your rm needs to issue substantial amounts of debt to get o the ground. What strategy might you employ in order to protect the value of the rm against interest rate risk?
net worth immunization In this case, you have no end date to base your strategy off . However, you can attempt to balance the interest rate exposure of your assets and liabilities by employing a net worth immunization strategy.
according to our class discussion, a bank would most likely use ______ to manage its interest rate risk.
net-worth immunization : A bank has significant assets and liabilities that are interest rate sensitive. Moreover, it has no particular investment horizon, as it would generally expect to continue as a going concern. Hence, it would most likely employ a net worth immunization strategy.
which of the following implies a higher duration? a higher coupon rate a higher yield to maturity a shorter maturity all of these none of these
none of these higher duration corresponds to higher interest rate risk. all three of these factors would result in a lower duration. so, the answer is none of these
Which of the following INCREASES interest rate risk? higher coupon rate higher yield to maturity shorter maturity all of these increase interest rate risk none of these increase interest rate risk
none of these increase interest rate risk interest rate risk increases with longer maturity and lower coupon rates/yields to maturity. hence, none of these increase interest rate risk.
suppose you are given a bond that has 10 years to maturity, with 5% annual coupon payment and a 7% yield to maturity. according to our discussion, which of the following would increase this bond's duration? -change coupon rate to 6% -change maturity to 9 years -change yield to maturity to 8%
none of these would increase its duration bonds with longer maturities, lower coupons, and lower yields are more sensitive to interest rate risk than other bonds. here, the changes would result in a higher coupon (A), a lower maturity (B), and a higher yield (C). all of these changes would actually reduce the interest rate risk and decrease the bond's duration. hence, none of these would increase its duration.
which of the following choices is NOT a direct factor in calculating a bond's interest rate risk? coupon rate maturity number of bonds issued yield to maturity
number of bonds issued the number of bonds issued does not directly affect the bond's interest rate risk, as it does not have a direct impact on the characteristics of an individual bond,
you are attempting to set up a net-worth immunized portfolio. you have figured that your liabilities have a duration of 10 years and a convexity of 85. according to our discussion, which of the following would be most appropriate immunization portfolio?
portfolio c: duration of 10 and convexity of 89 An immunization portfolio should have duration equal to your liabilities, with a convexity that is greater than that of the liabilities but with as little excess as possible. Portfolios A and E have incorrect durations. Portfolio B has too little convexity. So, portfolios C and D would both be acceptable. However, portfolio C is preferable, as its convexity of 89 is only slightly greater than that of the liabilities. So, it should be more cost efficient than portfolio D while still providing adequate protection if rates change.
based on our discussion, we're able to use duration to accurately approximate price changes for _______ changes in the interest rates/
small these approximation formulas are accurate for small changes.
Your retirement fund consists of a large amount of bonds. You have 40 years until retirement. Given today's low interest rates, you fear rates rising in the future, so you want to protect your portfolio from interest rate risk until you enter retirement. What strategy might you employ?
target date immunization given that you have a definite end date in mind, the most effective strategy of those listed is target date immunizations.
You are planning for retirement. You figure that you'll be able to retire in about 40 years. Which of the following strategies would you employ to protect your investments from interest rate risk?
target date immunization since you have a specific investment horizon, target date immunization would make the most sense.
_________ is a bond strategy that relies on perfectly offsetting the interest rate risk of the portfolio with its reinvestment risk.
target date immunization target date immunization is a bond strategy that works by setting the duration of the portfolio equal to the investor's horizon. this allows the interest rate risk of the portfolio to be offset by its reinvestment risk
you calculated the Macaulay duration of a perpetuity to be 24 years. what would the Macaulay duration of this security be in 5 years? Assume there is no change in yield over that time.
24 years assuming there is no change in yields, the Macaulay duration is exactly the same as it is now. hence, it will remain 24 years.
Which of the following bonds would you expect to have the highest interest rate risk? Assume that the maturities are the same.
a zero coupon with a 6% yield to maturity according to our discussion, higher maturities, lower coupon rates, and low yields to maturity are associated with higher interest rate risk. of these bonds, the zero coupon bond with a 6% yield to maturity is tied for the highest maturity (they're all the same), the lowest coupon rate (0%) and the lowest yield to maturity (6%). hence, we would expect it to have the most interest rate risk in this group.
which of the following is NOT a problem with approximating the price range of a bond when interest rates move using duration? bad at modeling larger rate movements only an approximation takes as much time as exact answers using a straight line to model a curved relationship all of these are problems
all of these are problems Approximating the price change using duration is a problematic approach. It isn't exact - and gets worse with larger changes, due to the non-linear relationship - and yet takes as long or longer than the exact answers given modern computing resources. Thus, all of these are problems with this approach.
which of the following is NOT true of the duration of a perpetual bond? -a higher duration implies higher price sensitivity to interest rate changes -equivalent interest rate risk to a zero coupon bond that matures at its duration -it only depends on the yield of the bond -the bond continues after the Macaulay duration -all of these are true
all of these are true All of these are true. A higher duration implies higher sensitivity to interest rate changes, and it is used to compare between bonds - equal durations imply equal interest rate risk. Since the duration of a zero is equal to its maturity, this means that the perpetual bond has equivalent interest rate risk to a zero that matures at its Macaulay duration, even though it continues on for an in nite period of time. Also, we are able to calculate the duration of the perpetuity using only the yield of the bond.
which of the following is not an issue with using duration to predict price changes as a result of interest rate changes?
approximation formula is too complicated B, C, and D are all true. the assertion in A that the approximation formula is too complicated is false (or least true)
__________ bonds can exhibit negative effective convexity, which means that their _______ can decrease when interest rates decrease.
callable; duration the prices of callable bonds cannot increase beyond the call price. this means that their increase in price will slow as interest rates decrease. this means that their duration can decrease. however, their price will continue to increase, albeit at a slower rate.
what is a problem with using duration?
changes with interest rates since duration is calculated using the market yield, this means that it will change with interest rates.
according to our class discussion, we are unable to precisely immunize our portfolio because duration _______.
changes with interest rates when attempting to immunize, we want to the duration of our portfolio to be set at a particular value. however, the duration of the portfolio will change when interest rates change, resulting in "errors" in our immunization.
a major problem with using duration to approximate bond price changes is that we are trying to match the actual _________ relationship with a ________ estimate.
curved; straight the actual relationship between the bond price and its yield is curved, while the estimated relationship between the two is straight
