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					Chapter 11 - Managing Bond Portfolios


                                                                          Chapter 11
                                                              Managing Bond Portfolios

Multiple Choice Questions



1. All other things equal, 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



2. All other things equal, 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



3. 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. 2.00 years
B. 2.15 years
C. 2.29 years
D. 2.53 years



4. 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 20 year zero coupon bond yielding 11%




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Chapter 11 - Managing Bond Portfolios



5. The duration of a perpetuity varies _______ with interest rates.
A. directly
B. inversely
C. convexly
D. randomly



6. 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



7. 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%. To take advantage of this you should do which of the following?
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



8. 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



9. A bond's price volatility _________ at a/an _________ rate as maturity increases.
A. increases; increasing
B. increases; decreasing
C. decreases; increasing
D. decreases; decreasing




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Chapter 11 - Managing Bond Portfolios



10. 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 is indeterminate.



11. All else equal, bond price volatility is greater for __________.
A. higher coupon rates
B. lower coupon rates
C. shorter maturity
D. lower default risk



12. ______________ is an important characteristic of the relationship between bond prices
and yields.
A. Convexity
B. Concavity
C. Complexity
D. Linearity



13. 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



14. The pioneer of the duration concept was _________.
A. Eugene Fama
B. John Herzog
C. Frederick Macaulay
D. Harry Markowitz




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15. 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 pick up
B. a rate anticipation
C. a substitution
D. an intermarket spread



16. The duration of a 5-year zero coupon bond is ____ years.
A. 4.5
B. 5.0
C. 5.5
D. 3.5



17. 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 pick up
B. a rate anticipation
C. a substitution
D. an inter-market spread



18. Target date immunization would primarily be of interest to _________.
A. banks
B. mutual funds
C. pension funds
D. individual investors



19. Duration is a concept that is useful in assessing a bond's _________.
A. credit risk
B. liquidity risk
C. price volatility
D. convexity risk




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Chapter 11 - Managing Bond Portfolios



20. 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%
B. 48%
C. 33%
D. 25%



21. 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. +1.40%
B. -1.40%
C. -2.51%
D. +2.51%



22. 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



23. 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 is indeterminate




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Chapter 11 - Managing Bond Portfolios



24. 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



25. 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



26. 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. indeterminate when the coupon rate is high



27. 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



28. In the context of a bond portfolio, price risk and reinvestment rate risk exactly cancel out
at a time horizon equal to ____.
A. the average bond maturity in the portfolio
B. the duration of the portfolio
C. the difference between the shortest duration and longest duration of the individual bonds in
the portfolio
D. the average of the shortest duration and longest duration of the bonds in the portfolio




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Chapter 11 - Managing Bond Portfolios



29. Bond portfolio immunization techniques balance ________ and ________ risk.
A. price; reinvestment
B. price; liquidity
C. credit; reinvestment
D. credit; liquidity



30. You have purchased a Guaranteed Investment contracts (GICs) 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



31. 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 weighed 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



32. 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



33. Which of the following is not a type of bond swap used in active portfolio management?
A. Inter-market spread swap
B. Substitution swap
C. Rate anticipation swap
D. Asset-liability swap




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Chapter 11 - Managing Bond Portfolios



34. The exchange of one bond for a bond with similar attributes but more attractively priced is
called ______________.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap



35. Rank the interest sensitivity of the following from 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



36. A bond swap made in response to forecasts of interest rate changes is called ______.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap



37. Moving to higher yield bonds, usually with longer maturities is called ________.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap



38. 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




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Chapter 11 - Managing Bond Portfolios



39. The duration rule always ________ the value of a bond following a change in its yield.
A. under-estimates
B. provides an unbiased estimate of
C. over-estimates
D. The estimated price may be biased either upward or downward, depending on whether the
bond is trading at a discount or a premium



40. 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



41. A bond currently has a price of $1,050. The yield on the bond is 6.00%. 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



42. A bond has a current price of $1,030. The yield on the bond is 8.00%. If the yield changes
from 8.00% to 8.10%, the price of the bond will go down to $1,025.88. The modified duration
of this bond is _________.
A. 4.32
B. 4.00
C. 3.25
D. 3.75




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Chapter 11 - Managing Bond Portfolios



43. A bank has $50 million in assets, $47 million in liabilities and $3 million in shareholders'
equity. If the duration of its liabilities are 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. 1.50
C. 1.60
D. 2.00



44. 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



 A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures
in four years. Its yield to maturity is currently 6%.



45. The duration of this bond is _______ years.
A. 2.44
B. 3.23
C. 3.56
D. 4.10



46. The modified duration of this bond is ______ years.
A. 4.00
B. 3.56
C. 3.36
D. 3.05




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Chapter 11 - Managing Bond Portfolios



47. A bond has a maturity of 12 years, 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



48. 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%. Over the upcoming year, you expect interest rates to decline and
that the yield to maturity on this bond will only be 8% a year from now. Using horizon
analysis, the return you expect to earn by holding this bond over the upcoming year is
_________.
A. 10.0%
B. 12.0%
C. 21.6%
D. 29.6%



49. A bond with a 9-year duration is worth $1,080.00 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
_________.
A. $1,035
B. $1,036
C. $1,094
D. $1,124



50. 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, then declines




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Chapter 11 - Managing Bond Portfolios



51. Duration facilitates the comparison of bonds with differing ___________.
A. default risk
B. conversion ratios
C. maturities
D. yields to maturity



52. 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



53. 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



54. A fixed income portfolio manager sets a minimum acceptable rate of return on the bond
portfolio at 5% per year over the next 4 years. The portfolio is currently worth $10 million.
One year later interest rates are at 6%. What is the portfolio value trigger point at this time
that would require him to immunize the portfolio?
A. $12,155,063
B. $10,205,625
C. $9,627,948
D. $10,500,000




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Chapter 11 - Managing Bond Portfolios



55. Compute the duration of an 8%, 5-year corporate bond with a par value of $1000 if yield
to maturity of 10%.
A. 3.92
B. 4.28
C. 4.55
D. 5.00



56. 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. 3.00



57. An 8%, 30-year bond has a yield-to-maturity of 10% and a modified duration of 8.0 years.
If the market yield drops by 15 basis points, there will be a __________ in the bond's price.
A. 1.15% decrease
B. 1.20% increase
C. 1.53% increase
D. 2.43% decrease



58. 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%




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Chapter 11 - Managing Bond Portfolios



59. 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.



60. An investor who expects declining interest rates would maximize their 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



61. 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. Absent 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



62. 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




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Chapter 11 - Managing Bond Portfolios



 Steel Pier Company has issued bonds that pay semiannually with the following
characteristics:




63. 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



64. 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. There is not enough information to determine the direction of change



65. 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. There is not enough information to determine the direction of change



66. If the yield to maturity decreases to 8.045% the expected percentage change in the price of
the bond using Macauley's duration would be ____, while the expected percentage change in
the price of the bond using modified duration would be ____.
A. 11%, 12%
B. 12%, 11%
C. 12%, 12%
D. 11%, 11%




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Chapter 11 - Managing Bond Portfolios



67. 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 five
years yield rates on these bonds will be at 7.0%. You believe that you will be able to reinvest
the coupons earned over the next five years at a 6% rate of return. What is your expected
annual compound rate of return if you plan on selling the bond in five years?
A. 7.37%
B. 7.56%
C. 8.12%
D. 8.54%



68. 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



69. A zero coupon bond is selling at a deep discount price of $430.00. 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. 8.0 years
C. 10 years
D. 13 years



70. You have an investment that in today's dollars returns 15% of your investment in year 1,
12% in year two, 9% in year 3 and the remainder in year 4. What is the duration of this
investment?
A. 4 years
B. 3.50 years
C. 3.22 years
D. 2.95 years




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71. 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



72. 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



73. 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



74. 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. one can't tell with the information given



75. A bond portfolio manager notices a hump in the yield curve at the five 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




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76. 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.



77. 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. one can't tell with the information given



78. 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



79. 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




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Chapter 11 - Managing Bond Portfolios



80. Immunization of coupon paying bonds is not a passive strategy 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



81. 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 institution's 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



82. Convexity implies that duration predictions _______.
I. underestimate the % increase in bond price when the yield falls
II. underestimate the % decrease in bond price when the yield rises
III. overestimates the % increase in bond price when the yield falls
IV. overestimates the % decrease in bond price when the yield rises
A. I and III only
B. II and IV only
C. I and IV only
D. II and III only




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Chapter 11 - Managing Bond Portfolios



83. You have a 25 year maturity 10% coupon, 10% yield bond with duration of 10 years and a
convexity of 135.50. If interest rate were to fall 125 basis points your predicted new price for
the bond (including convexity) is _________.
A. $1098.45
B. $1104.56
C. $1113.41
D. $1124.20



84. You have a 15 year maturity 4% coupon, 6% yield bond with duration of 10.5 years and a
convexity of 128.75. The bond is currently priced at $805.76. If interest rate were to increase
200 basis points your predicted new price for the bond (including convexity) is _________.
A. $638.85
B. $642.54
C. $666.88
D. $705.03



85. Convexity of a bond is ___________.
A. the same as horizon analysis
B. the rate of change of the price-yield curve divided by bond price
C. a measure of bond duration
D. none of the above




Chapter 11 Managing Bond Portfolios Answer Key



Multiple Choice Questions




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Chapter 11 - Managing Bond Portfolios



1. All other things equal, 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


Difficulty: Medium



2. All other things equal, 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


Difficulty: Medium



3. 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. 2.00 years
B. 2.15 years
C. 2.29 years
D. 2.53 years




Difficulty: Hard




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Chapter 11 - Managing Bond Portfolios



4. 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 20 year zero coupon bond yielding 11%


Difficulty: Medium



5. The duration of a perpetuity varies _______ with interest rates.
A. directly
B. inversely
C. convexly
D. randomly


Difficulty: Medium



6. 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


Difficulty: Easy



7. 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%. To take advantage of this you should do which of the following?
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


Difficulty: Medium




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Chapter 11 - Managing Bond Portfolios



8. 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


Difficulty: Easy



9. A bond's price volatility _________ at a/an _________ rate as maturity increases.
A. increases; increasing
B. increases; decreasing
C. decreases; increasing
D. decreases; decreasing


Difficulty: Easy



10. 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 is indeterminate.


Difficulty: Medium



11. All else equal, bond price volatility is greater for __________.
A. higher coupon rates
B. lower coupon rates
C. shorter maturity
D. lower default risk


Difficulty: Easy




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Chapter 11 - Managing Bond Portfolios



12. ______________ is an important characteristic of the relationship between bond prices
and yields.
A. Convexity
B. Concavity
C. Complexity
D. Linearity


Difficulty: Medium



13. 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


Difficulty: Easy



14. The pioneer of the duration concept was _________.
A. Eugene Fama
B. John Herzog
C. Frederick Macaulay
D. Harry Markowitz


Difficulty: Easy



15. 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 pick up
B. a rate anticipation
C. a substitution
D. an intermarket spread


Difficulty: Easy




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Chapter 11 - Managing Bond Portfolios



16. The duration of a 5-year zero coupon bond is ____ years.
A. 4.5
B. 5.0
C. 5.5
D. 3.5


Difficulty: Easy



17. 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 pick up
B. a rate anticipation
C. a substitution
D. an inter-market spread


Difficulty: Easy



18. Target date immunization would primarily be of interest to _________.
A. banks
B. mutual funds
C. pension funds
D. individual investors


Difficulty: Easy



19. Duration is a concept that is useful in assessing a bond's _________.
A. credit risk
B. liquidity risk
C. price volatility
D. convexity risk


Difficulty: Easy




                                              11-25
Chapter 11 - Managing Bond Portfolios



20. 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%
B. 48%
C. 33%
D. 25%


Durperpetuity =   = 26 years
15 = (wz)(5) + (1 - wz) 26; wz = 52.38%


Difficulty: Hard



21. 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. +1.40%
B. -1.40%
C. -2.51%
D. +2.51%



%P = (-6)           = -1.40%


Difficulty: Medium



22. 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


Difficulty: Easy




                                              11-26
Chapter 11 - Managing Bond Portfolios



23. 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 is indeterminate


Difficulty: Medium



24. 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


Difficulty: Medium



25. 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


Difficulty: Medium



26. 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. indeterminate when the coupon rate is high


Difficulty: Easy




                                              11-27
Chapter 11 - Managing Bond Portfolios



27. 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


Difficulty: Medium



28. In the context of a bond portfolio, price risk and reinvestment rate risk exactly cancel out
at a time horizon equal to ____.
A. the average bond maturity in the portfolio
B. the duration of the portfolio
C. the difference between the shortest duration and longest duration of the individual bonds in
the portfolio
D. the average of the shortest duration and longest duration of the bonds in the portfolio


Difficulty: Easy



29. Bond portfolio immunization techniques balance ________ and ________ risk.
A. price; reinvestment
B. price; liquidity
C. credit; reinvestment
D. credit; liquidity


Difficulty: Easy




                                             11-28
Chapter 11 - Managing Bond Portfolios



30. You have purchased a Guaranteed Investment contracts (GICs) 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

(10,000)(1.05)6 = $13,401


Difficulty: Easy



31. 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 weighed 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


Difficulty: Medium



32. 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


Difficulty: Medium




                                            11-29
Chapter 11 - Managing Bond Portfolios



33. Which of the following is not a type of bond swap used in active portfolio management?
A. Inter-market spread swap
B. Substitution swap
C. Rate anticipation swap
D. Asset-liability swap


Difficulty: Easy



34. The exchange of one bond for a bond with similar attributes but more attractively priced is
called ______________.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap


Difficulty: Easy



35. Rank the interest sensitivity of the following from 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


Difficulty: Hard



36. A bond swap made in response to forecasts of interest rate changes is called ______.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap


Difficulty: Easy




                                              11-30
Chapter 11 - Managing Bond Portfolios



37. Moving to higher yield bonds, usually with longer maturities is called ________.
A. a substitution swap
B. an intermarket spread swap
C. rate anticipation swap
D. pure yield pickup swap


Difficulty: Easy



38. 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


Difficulty: Easy



39. The duration rule always ________ the value of a bond following a change in its yield.
A. under-estimates
B. provides an unbiased estimate of
C. over-estimates
D. The estimated price may be biased either upward or downward, depending on whether the
bond is trading at a discount or a premium


Difficulty: Medium



40. 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


Difficulty: Medium




                                            11-31
Chapter 11 - Managing Bond Portfolios



41. A bond currently has a price of $1,050. The yield on the bond is 6.00%. 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


P =                 = -0.019

P = -0.019 = -Dur              ; Dur = 8.08


Difficulty: Medium



42. A bond has a current price of $1,030. The yield on the bond is 8.00%. If the yield changes
from 8.00% to 8.10%, the price of the bond will go down to $1,025.88. The modified duration
of this bond is _________.
A. 4.32
B. 4.00
C. 3.25
D. 3.75



P =                      = -0.004


P = -0.004 = -Dur               ; Dur = 4.32

DurMOD =             =4


Difficulty: Hard




                                                11-32
Chapter 11 - Managing Bond Portfolios



43. A bank has $50 million in assets, $47 million in liabilities and $3 million in shareholders'
equity. If the duration of its liabilities are 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. 1.50
C. 1.60
D. 2.00

(50,000,000)(DA) = (47,000,000) (1.3); DA = 1.22


Difficulty: Medium



44. 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




Difficulty: Medium



 A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures
in four years. Its yield to maturity is currently 6%.




                                              11-33
Chapter 11 - Managing Bond Portfolios



45. The duration of this bond is _______ years.
A. 2.44
B. 3.23
C. 3.56
D. 4.10



Duration = 3.56


Difficulty: Hard



46. The modified duration of this bond is ______ years.
A. 4.00
B. 3.56
C. 3.36
D. 3.05

DurMOD = 3.56/1.06 = 3.36 years


Difficulty: Hard



47. A bond has a maturity of 12 years, 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

DurMOD = 9.5/1.08 = 8.8 years


Difficulty: Easy




                                             11-34
Chapter 11 - Managing Bond Portfolios



48. 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%. Over the upcoming year, you expect interest rates to decline and
that the yield to maturity on this bond will only be 8% a year from now. Using horizon
analysis, the return you expect to earn by holding this bond over the upcoming year is
_________.
A. 10.0%
B. 12.0%
C. 21.6%
D. 29.6%



                                         (use financial calculator to calculate PV10%, 20 and
PV8%, 19)


Difficulty: Hard



49. A bond with a 9-year duration is worth $1,080.00 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
_________.
A. $1,035
B. $1,036
C. $1,094
D. $1,124




Difficulty: Hard



50. 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, then declines


Difficulty: Easy




                                             11-35
Chapter 11 - Managing Bond Portfolios



51. Duration facilitates the comparison of bonds with differing ___________.
A. default risk
B. conversion ratios
C. maturities
D. yields to maturity


Difficulty: Easy



52. 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


Difficulty: Medium



53. 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


Difficulty: Medium




                                              11-36
Chapter 11 - Managing Bond Portfolios



54. A fixed income portfolio manager sets a minimum acceptable rate of return on the bond
portfolio at 5% per year over the next 4 years. The portfolio is currently worth $10 million.
One year later interest rates are at 6%. What is the portfolio value trigger point at this time
that would require him to immunize the portfolio?
A. $12,155,063
B. $10,205,625
C. $9,627,948
D. $10,500,000

Minimum terminal value = ($10 mill.)(1.05)4 = $12,155,062.50
Trigger point value = $12,155,062.50/1.063 = $10,205,625


Difficulty: Hard



55. Compute the duration of an 8%, 5-year corporate bond with a par value of $1000 if yield
to maturity of 10%.
A. 3.92
B. 4.28
C. 4.55
D. 5.00




Difficulty: Medium




                                              11-37
Chapter 11 - Managing Bond Portfolios



56. 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. 3.00




Difficulty: Medium



57. An 8%, 30-year bond has a yield-to-maturity of 10% and a modified duration of 8.0 years.
If the market yield drops by 15 basis points, there will be a __________ in the bond's price.
A. 1.15% decrease
B. 1.20% increase
C. 1.53% increase
D. 2.43% decrease

(P/P) = - 8.0 (0.0015) = - 0.012


Difficulty: Medium




                                            11-38
Chapter 11 - Managing Bond Portfolios



58. 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%




Difficulty: Hard



59. 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.


Difficulty: Easy



60. An investor who expects declining interest rates would maximize their 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


Difficulty: Easy




                                              11-39
Chapter 11 - Managing Bond Portfolios



61. 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. Absent 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


Difficulty: Easy



62. 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


Difficulty: Easy



 Steel Pier Company has issued bonds that pay semiannually with the following
characteristics:




                                           11-40
Chapter 11 - Managing Bond Portfolios



63. 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

DurMOD = 6.76/1.10 = 6.15 years


Difficulty: Medium



64. 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. There is not enough information to determine the direction of change


Difficulty: Easy



65. 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. There is not enough information to determine the direction of change


Difficulty: Easy




                                            11-41
Chapter 11 - Managing Bond Portfolios



66. If the yield to maturity decreases to 8.045% the expected percentage change in the price of
the bond using Macauley's duration would be ____, while the expected percentage change in
the price of the bond using modified duration would be ____.
A. 11%, 12%
B. 12%, 11%
C. 12%, 12%
D. 11%, 11%



%P =                                   ; %P is the same using DurMOD


Difficulty: Hard



67. 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 five
years yield rates on these bonds will be at 7.0%. You believe that you will be able to reinvest
the coupons earned over the next five years at a 6% rate of return. What is your expected
annual compound rate of return if you plan on selling the bond in five years?
A. 7.37%
B. 7.56%
C. 8.12%
D. 8.54%



FV5coupons =



P5Bond =
Total Future Value5 = $366.41 + $954.46 = $1,320.87
PV0 = $925.50
($925.50)(1 + r)5 = $1,320.87; r = 7.37%


Difficulty: Hard




                                               11-42
Chapter 11 - Managing Bond Portfolios



68. 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


Difficulty: Medium



69. A zero coupon bond is selling at a deep discount price of $430.00. 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. 8.0 years
C. 10 years
D. 13 years

Duration of a zero-coupon bond is equal to its maturity.


Difficulty: Easy



70. You have an investment that in today's dollars returns 15% of your investment in year 1,
12% in year two, 9% in year 3 and the remainder in year 4. What is the duration of this
investment?
A. 4 years
B. 3.50 years
C. 3.22 years
D. 2.95 years

Dur = (15%)(1) + (12%)(2) + (9%)(3) + (64%)(4) = 3.22 years


Difficulty: Medium




                                              11-43
Chapter 11 - Managing Bond Portfolios



71. 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


Difficulty: Easy



72. 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


Difficulty: Hard



73. 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


Difficulty: Medium



74. 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. one can't tell with the information given


Difficulty: Medium




                                            11-44
Chapter 11 - Managing Bond Portfolios



75. A bond portfolio manager notices a hump in the yield curve at the five 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


Difficulty: Medium



76. 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.


Difficulty: Medium



77. 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. one can't tell with the information given


Difficulty: Medium



78. 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


Difficulty: Medium




                                             11-45
Chapter 11 - Managing Bond Portfolios



79. 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


Difficulty: Medium



80. Immunization of coupon paying bonds is not a passive strategy 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


Difficulty: Medium



81. 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 institution's 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


Difficulty: Medium




                                              11-46
Chapter 11 - Managing Bond Portfolios



82. Convexity implies that duration predictions _______.
I. underestimate the % increase in bond price when the yield falls
II. underestimate the % decrease in bond price when the yield rises
III. overestimates the % increase in bond price when the yield falls
IV. overestimates the % decrease in bond price when the yield rises
A. I and III only
B. II and IV only
C. I and IV only
D. II and III only


Difficulty: Hard



83. You have a 25 year maturity 10% coupon, 10% yield bond with duration of 10 years and a
convexity of 135.50. If interest rate were to fall 125 basis points your predicted new price for
the bond (including convexity) is _________.
A. $1098.45
B. $1104.56
C. $1113.41
D. $1124.20

PV0 = $1,000


%P =
PNew = ($1,000)(1 + 0.1242) = $1,124.20


Difficulty: Hard




                                             11-47
Chapter 11 - Managing Bond Portfolios



84. You have a 15 year maturity 4% coupon, 6% yield bond with duration of 10.5 years and a
convexity of 128.75. The bond is currently priced at $805.76. If interest rate were to increase
200 basis points your predicted new price for the bond (including convexity) is _________.
A. $638.85
B. $642.54
C. $666.88
D. $705.03

PV0 = $805.76

%P =
PNew = ($805.76)(1 + -0.1724) = $666.88


Difficulty: Hard



85. Convexity of a bond is ___________.
A. the same as horizon analysis
B. the rate of change of the price-yield curve divided by bond price
C. a measure of bond duration
D. none of the above


Difficulty: Medium




                                             11-48

				
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