Question 1 - Measuring Yield

a) Define the following terms.

(i) Current yield

(ii) Yield to worst (4 marks)

b) A bond pays 8.5% semi-annual coupons, has a $1000 par value, 30 years to maturity and a price of $1100.

(i) Calculate the yield to maturity of this bond on a bond-equivalent basis. (2 marks)

(ii) Assuming coupon payments of this bond can be reinvested at 10% over the 30-year

period, what can you say about the realized yield of this bond at maturity? (You do not need to do any calculations for this part.) (2 marks)

(iii) If the conditions under (ii) prevailed, calculate the interest-on-interest earned by the bond-holder over the 30-year holding period. (4 marks) (Total 12 marks)

Question 2 - Bond Price Volatility

a) Briefly explain four aspects of the price volatility of an option-free bond. (6 marks)

b)  Bond X has a $1,000 par value, 8% semi-annual coupons, a maturity of 3 years and sells at par. Calculate the following for Bond X.

(i)  Modified Duration (4 marks)

(ii) Convexity (4 marks) (Total 14 marks)

Question 3 - Factors affecting bond yields and the term structure of interest rates

a) Explain why a country’s swap curve may be preferred to a country’s Treasury bond yield curve. (3 marks)

b) Consider the following bonds.

Corporate Bonds

Bond issue YY, rated AA, YTM= 10%, term to maturity = 10 years

Bond issue ZZ, rated BBB,YTM= 11%, term to maturity = 15 years

Treasury Bonds

Bond issue QQ, YTM 8%, term to maturity = 10 years

Bond issue RR, YTM 9.5%, term to maturity = 15 years

(i) Calculate the benchmark spreads for the two corporate bonds. (3 marks)

(ii) From your answer to part (i), what can you determine about the two corporate bonds? (3 marks)

c) 1-year, 1.5-year and 2-year spot rates are 5% p.a., 6% p.a. and 7% p.a., respectively. Calculate the 6-month and 1-year forward rates at the end of one year. (5 marks) (Total 14 marks)

Question 4 - Treasury and federal agency securities

a) What is meant by coupon stripping in relation to STRIPs?  What is the key feature of STRIPs? What is the main usage of STRIPs in today’smarket? (4 marks)

b) Briefly explain how a change in inflation would affect the returns of a TIPS holder. (4 marks)

c) Name any two institutions that can issue agency mortgage-backed securities. (2 marks) (Total 10 marks)

Question 5 - Corporate debt instruments

a) Corporate bonds usually trade on electronic trading systems. Explain what a corporate bond auction system and an interdealer system are. (4 marks)

b) There are two unique risks that can change corporate credit spreads: event risk and headline risk. Explain the difference between these two types of risk. (4 marks)

c) Briefly explain what roll-over risk is in relation to commercial paper and the remedy available to the investor to overcome this problem. (4 marks) (Total 12 marks)

Question 6 - Bond portfolio management strategies

Below are the characteristics of two portfolios with a market value of $200 million. The bonds in both portfolios are trading at par value. For simplicity, assume that the dollar   duration of the two portfolios is the same.

(a) Which portfolio can be characterized as a bullet portfolio and explain why? (4 marks)

(b) Which portfolio can be characterized as a barbell portfolio and explain why? (4 marks)

(c) As stated above, assume that the two portfolios (I and II) have the same dollar

duration. Explain how their performance will change when there is a parallel shift in the term structure of interest rates. (6 marks) (Total 14 marks)

Question 7 - Bond portfolio construction

a) What are two key concerns when applying Markowitz’s portfolio variance to bond portfolio construction? (4 marks)

b) Mr. Du Du is a portfolio manager. He has a meeting with a potential pension client.     During the meeting,he claims that his firm does not use a multi-factor risk model since

the only purpose of a multifactor risk model is to describe the risk profile of the

managed portfolios relative to the risk profile of the bond market index that the client specifies.

Mr. Du Du claims that this can more easily be done by comparing the effective duration, spread duration, and key rate durations of the portfolio and the benchmark index.

Provide two main reasons why you agree, or disagree, with Mr. Du Du. (6 marks) (Total 10 marks)

Question 8 - Bond performance measurement & evaluation

a) There are many performance attribution models that are available from third party vendors. Explain two features these models should possess to evaluate the decision-making ability of the members of the portfolio management team. (4 marks)

b) Performance attribution models can be used to explain why the active return of a

portfolio was realized. Describe two different types of performance attribution models. (6 marks)

c) A bond portfolio manager has earned returns of -11% p.a., -2% p.a. and -17% p.a.

over the past three years. Calculate both the arithmetic and the time-weighted average annual rates of return for the manager. (4 marks) (Total 14 marks)