7. (4 points) Outline the risks faced by a U.S. investor in purchasing a 10-year privatelyplaced
U.S. corporate callable bond.
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Morning Session
COURSE 6
MORNING SESSION
SECTION B – MULTIPLE CHOICE
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Morning Session
1-5. Each of questions 1 through 5 consists of two lists. In the list at the left are two items,
lettered X and Y. In the list at the right are three items, numbered I, II and III. ONE of
the lettered items is related in some way to EXACTLY TWO of the numbered items.
Indicate the related items using the following answer code:
Lettered Item
Is Related to Numbered Items
(A)
X
I and II only
(B)
X
II and III only
(C)
Y
I and II only
(D)
Y
I and III only
(E)
The correct answer is not given by (A), (B), (C) or (D).
1. X. Yield-to-maturity return method I. Requires an explicit reinvestment
rate assumption
Y. Total return method II. Is commonly used for pricing and
trading
III. Ignores the capital gain or loss from
security sales
2. X. Effective duration matching I. Very expensive to implement
Y. Cash flow matching II. Only works for small changes in
interest rates
III. Accounts for options embedded in
the assets and liabilities
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Morning Session
3. X. Tracking error of 68 basis points I. Assuming a normal distribution, there
is a 68% probability that the portfolio
return over the next year will be
within one standard deviation of the
annualized benchmark return
Y. Portfolio β of 68% II. The portfolio has less volatility than
the benchmark
III. Expect a 68 basis point increase in the
portfolio return if there is a 100 basis
point increase in the benchmark return
4. X. Planned amortization classes I. Priced at tighter spreads to the
Treasury curve than sequential-pay
bonds
Y. Accretion-directed classes II. Redirect principal only
III. Complete protection against
extension of average life if interest
rates rise
5. X. Increase in volatility I. Decreases the value of a putable
bond
Y. Decrease in volatility II. Increases the value of a call option
III. For a given price, increases the
option-adjusted spread for a putable
bond
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Morning Session
6-10. Questions 6 through 10 consist of an assertion in the left-hand column and a reason in the
right-hand column. Code your answer to each question by blackening space:
(A) If both the assertion and the reason are true statements, and the reason is a correct
explanation of the assertion.
(B) If both the assertion and the reason are true statements, but the reason is NOT a
correct explanation of the assertion.
(C) If the assertion is a true statement, but the reason is a false statement.
(D) If the assertion is a false statement, but the reason is a true statement.
(E) If both the assertion and the reason are false statements.
6.
ASSERTION
Returns on the S&P 500 stock
index are not affected by stock
splits.
BECAUSE
REASON
Returns on market-value-weighted
indices are based on holding
investments in proportion to their
market values.
7.
ASSERTION
The extended Vasicek model is
able to provide an exact fit to the
current term structure of interest
rates.
BECAUSE
REASON
The drift term in the extended
Vasicek model is time-independent.
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Morning Session
8.
ASSERTION
Firm-wide stress tests are
reviewed frequently but changed
infrequently.
BECAUSE
REASON
Stress tests may be usefully
applied to markets in which
illiquid conditions produce asset
price jumps and impede securities
trading during times of stress.
9.
ASSERTION
The FHA experience method is
rarely used as a prepayment
model.
BECAUSE
REASON
The FHA experience method does
not reflect the effect of age on prepayments.