Chris Cianfarini

BF/BR 498-50
Bond Markets
Exam I Part I
1.

What are the 6 major sectors of the US Bond Market?

U.S. Treasury Sector
Agency Sector
Municipal Sector
Corporate Sector
Asset Backed Securities Sector
Mortgage Sector

2. What are the cash flows for a 10 year treasury note that has a face value of
$1,000,000 and a coupon of 4.5%?
X [ 1 - 1 / (1 + .0225)^20 / .0225] =1,000,000
X [ 1 - 1/ 1.56059201 / .0225]=1,000,000
X [1- .6408164715 / .0225]=1,000,000
X [15.96371238] = 1,000,000
X=62,642.07

3. ABC Corp issues a 3year floating rate note that has a coupon reset formula of
3 month LIBOR + 150 basis points and currently, 3 month LIBOR is quoted @
0.32%. What will be the initial coupon on this bond?
=LIBOR (.32%) + 1.5%
%1.5 + .32% =

%1.82 Coupon

4. If an investor chose the buy the bond in question #3 over a regular bond
(fixed coupon) issued by ABC Corp with a similar maturity, what could you
assume the investor thinks about the trend in interest rates over the next 3
years?
The investor thinks that the trend in interest rates over the
next 3
years will increase. He would rather have a floating Rate
note over a
regular fixed rate bond because he believes that
interest rates will
increase and if he took a fixed rate note it
would not be worth as
much.

5. Bond A is a 10 year note with a coupon of 5% and yielding 4.00%...what is its

price?
25 [ 1 - 1/ (1 + .02) ^20 /.02] =
25 [ 1- 1/ 1.485947 / .02] =
25 [ 1 -.672971 /.02] =
=408.786
1000 / (1 + .02)^20 =
1000/ 1.485947 =
= 672.971

(PV of coupon)

(PV of Maturity)

408.786 + 672.971=1081.757

PRICE = 108.175
6. Bond B is a 20 year bond with a 0% coupon yielding 6.00%...what is its price?
PV OF MATURITY= 1000 / (1.03)^ 40
Price=306.557 or 30.655
7. Bond C is a 3 year note with a coupon of 5.00% and a price of 102.801What is
its yield?
25 [ 1 - 1 / (1 +. 02 )^6 /.02] = 140.035
1000/ 1.02^6 = 887.971
887.971+ 140.035= 1,028.006
=102.801

Yield = 4%

(PV of Coupon)
(PV of Maturity)
(Price)

8. Name 3 different examples of embedded options in bonds. For each example,

state who the option benefits, the buyer or the issuer.
Call ProvisionGrants the issuer the right to retire the debt, fully, or partially,
before
scheduled maturity date.
This Benefits the Issuer because it allows them to replace an
outstanding
bond issue with a new bond issue that has a lower
coupon rate than the outstanding bond due to a decline in interest rates.
Convertible BondGrants the bondholder the right to exchange the bond for a specified
number of shares of common stock.
This Benefits the bondholder, not the issuer. This feature allows the
bondholder to take advantage of favorable movements in the price
of the
issuers common stock.
Put ProvisionIs an embedded option that allows a bondholder to change the
maturity of
a bond. This gives the bondholder the chance to sell a
bond back to the
issuer at par value on designated dates.
The advantage in this embedded option is in the favor of the
investor/bondholder. If market interest rates rise after the issuance
date and bring the price of the bond down the investor can force the
issuer to
redeem the bond at principal value.
9. What type of relationship do price and yield have on most bonds in existence?
When the price of most bonds go up, the yield reacts inversely,
causing prices to go down. Also, when yields go up, prices on
bonds
are sold at a discount.
slope or

Overall, the prices and yields usually have a negative

are considered inversely related.

10. What are the 9 major risks associated with investing in bonds?
Interest Rate Risk
Reinvestment Risk
Call Risk
Credit Risk
Inflation Risk
Exchange-Rate Risk
Liquidity Risk
Volatility Risk
Risk Risk
11. What is the one risk mentioned in #10 that is not present in the domestic (US)
bond market?
The Exchange-Rate Risk
12. Explain how reinvestment risk can have both a positive or negative impact on
the total return of a given bond, depending how rates move in the future.
The Negative aspect of Reinvestment risk is that the prevailing
market interest rate at which interim cash flows can be reinvested will fall.
The Positive impact of reinvestment is leverage. By putting the
money made by interest rates back in and the rates rise at interim, than
the investor will make even more money.
13. Provide the decimal prices for the following three US Treasury prices
99-16
.995
.995 X 1,000 ( Standard Par)= $995.00
102-04+
1.0215
1.02125 X 1,000 (Standard Par) = $1,021.25
100-29
1.0090625 1.0090625 X 1,000 (Standard Par) =
$1,009.06
14. Suppose you bought a bond 3 months ago as a new issue. You are going to sell
it today but it doesnt make its first coupon payment for another 3 months. How are
you compensated by the buyer for the interest that has accumulated buy not yet
paid?
When an Investor purchases a bond between coupon payments, the
investor must compensate the seller of the bond for the coupon interest
earned from the time of the last coupon payment to the settlement date of
the bond.

The compensation is called Accrued Interest

15. While it is commonplace to think of the term Duration as a measure of time,

with regard to the bond market, Duration is really a measure of ____________.
RISK
16. While the formula is somewhat flawed, basically, a bond with a duration of 7.5
means that if the yield of the bond moves by _______ basis point(s), the price will
move by _______%.
100 Basis Points and 7.5 %

17. Consider 2 bonds with the same maturity and yield. Bond A has a 5% coupon,
Bond B has a 7% coupon. Which bond has the greater duration?
The 5% bond coupon, bond A will have a greater duration.
18. Consider 2 bonds with the same coupon and yield. Bond Y matures in 5 years
and bond Z matures in 20 years. Which bond has the greater duration?
The 20 year bond z has the greater duration.
19. Suppose you are a fixed income money manager whose portfolio is largely made
up of 5 year Treasury notes. Now, suppose we have gone through a significant rise
in interest rates and you feel strongly that rates are going to reverse and go back
down. Which would be the correct trade to do if you are going to put your money
where your mouth isand why?
A. Swap to 2 year notes

20. What is the slope of a normal yield curve (positive, negative, flat)?
Positive

21.Since a given bonds price and yield are not linear, ___________ is the measure
used to examine different prices/yields plotted on a graph that compares the
actually price/yield line to a tangent line.
Convexity
22.Consider the graph below:

Assuming both bonds are being offered at the same yield, which bond would you
prefer..why?
If Both bonds are being offered at the same yield and same duration I
would take bond B Due to its Higher convexity.
No matter if the market rises or falls, Bond B will always have a
higher price. If required yield rises than the capital loss on bond B will
be less than it will be on bond A. If the the required yield falls then B
will still generate a greater price appreciation compared to Bond A

23. What are the on the run issues of the Treasury Market?
The on the run issues of the Treasury Market are the most recently
auctioned issue of a given maturity.
These issues include:
3 and 6 month Treasury bills
2, 5, and 10 Treasury Notes
30 year Treasury Bond
24. ________ are securities that are issued by the Treasury with 1 year or less to
maturity.
Treasury Bills
25.________ are Treasury securities that are created by dealers, have no coupon, and
have various maturities.
Separate Trading of registered Interest and Principal of
Securities
(Strips)