FIN 325 Chapter 16 Smartbook

When the coupon rate of a bond decreases, its duration ______.

increases

Many banks have a natural mismatch between the maturities of assets and liabilities; liabilities are primarily short-term deposits and assets are mostly long-term loans. This characteristic can make banks suffer serious decreases in net worth when ______.

interest rates increase unexpectedly

The term for matching the durations of assets and liabilities so as to make net worth unaffected by interest rate movements is

immunization

________ can be an inappropriate goal in an _________ environment.

immunization, inflationary

Which is the formula for the duration of a perpetuity?

(1+y)/y

Which of the following statements illustrate why convexity is generally considered a desirable trait?

-Bonds with greater curvature gain more in price when yields fall than they lose when yields rise. -Bonds that are more convex enjoy greater price increases and smaller decreases when interest rates fluctuate by larger amounts.

Which statements are true about the figure? (Click to enlarge.)

-The bond trading at par has a 15% coupon, and its duration increases with maturity. -The bond trading at a premium has a 15% coupon, and its duration increases with maturity. -For the zero-coupon bond, duration increases year-for-year with maturity.

Which statements about the interest rate sensitivity of bonds are correct?

-The sensitivity of bond prices to changes in yields increases at a decreasing rate as maturity increases. -An increase in a bond's yield to maturity results in a smaller price change than a decrease in yield of equal magnitude -As yields increase, bond prices fall.

Order the steps in calculating the duration of a bond.

1. Determine the size 2. Determine the present 3. Calculate the weight 4. multiply the cash 5. sum the product

Which statements about immunizing a bond portfolio are correct?

A bond portfolio will not remain immunized if the manger does not buy and sell securities to rebalance the portfolio. Immunization does not involve attempts to identify undervalued bonds.

True or false: For a horizon equal to the portfolio's duration, price risk and reinvestment risk are precisely equal.

False

Which statements are true of bond market indexing?

Indexes may include thousands of securities. Bonds are dropped from the index as they approach maturity and replaced with new issues. Many bonds are very thinly traded,

Which of the following are the sources of potential value only used in active bond management?

Identifying mispriced bonds Interest rate forecasting

Match the active bond portfolio management technique with its description.

Substitution swap matches Choice, The exchange of one bond for a bond with similar attributes but more attractively priced The exchange of one bond for a bond with similar attributes but more attractively priced Intermarket spread swap matches Choice, Switching from one segment of the bond market to another (e.g., from Treasuries to corporates) Switching from one segment of the bond market to another (e.g., from Treasuries to corporates) Rate anticipation swap matches Choice, A switch made in response to forecasts of interest rates A switch made in response to forecasts of interest rates Pure yield pickup swap matches Choice, Moving to higher-yield bonds Moving to higher-yield bonds

Bond A is a 10-year zero-coupon bond with yield to maturity of 10%. Bond B is a 15-year semi-annual coupon bond with yield to maturity of 10% and duration of 10 years. If the yields of both bonds increase to 10.25%, what can we reasonably predict?

The bonds will have a similar percentage change in price.

Which statements are true of the figure? (Click to enlarge.)

The duration approximation is linear. When the interest rate decreases, the bond's price changes more than predicted by the duration approximation.

Which of the following statements regarding duration is true?

The property of duration corresponds to Malkiel's third relationship. holding the coupon rate constant, a bond's duration generally increases with its time to maturity

If the yield to maturity of a bond increases, then its sensitivity to interest rate changes ______.

falls

If two bonds have the same present value of cash flows but differ in their convexity, the one with greater convexity would be expected to have ______ the one with lower convexity.

a higher price than

Holding interest rates constant, for bonds selling at par or at a premium to par, duration ______ increases with time to maturity.

always

Bond index funds are ______.

both exchange-traded and mutual funds

______ is matching cash flows from a fixed-income portfolio with those of an obligation on a multi-period basis.

dedication

In cases when cash flows are not known, as because of embedded optionality, the sensitivity of a bond to interest rate changes is described by ______ duration.

effective

Security P is a perpetuity, and Security Z is a zero coupon bond that has 15 years remaining until maturity. Both securities have a yield of 5%. The duration of Security P ______.

is longer than the duration of Security Z

Dedication is not as widely used as immunization because ______.

it imposes a severe constraint on bond selection

The difference between the predicted change in a bond's price using duration with and without accounting for convexity will be larger when the interest rate change is ______ and the bond is ______ convex.

large; more

The percentage change in a bond's price from a change in interest rates is best approximated by the negative of the product of the change in the bond's yield to maturity and ______

modified duration

In the region of _____ convexity, the price-yield curve exhibits an unattractive asymmetry.

negative

Fund P is a pension fund managing retirement portfolios for state employees, and the duration of their liability is 30 years. Fund P is immunized from interest rate risk if _______ and they continue to rebalance their portfolio.

the asset duration is also 30 years

Bond H and Bond L are zero-coupon bonds that have 10-years remaining until maturity, but Bond H has a higher yield to maturity than Bond L. Bond H's duration is ______ Bond L's duration. When the yields of both bonds increase by 50 basis points, the percentage drop in bond price will be ______.

the same as; greater for Bond L than Bond H

If a pension manager's portfolio only holds bond indexes, the manager will reduce the risk of _______.

underperforming the indexes

Holding the coupon rate constant, a bond's duration _______ increases with its time to maturity.

usually

The duration of a ____-_____ bond equals its time to maturity.

zero coupon