INV3702 ASSIGNMENT 1 SEMESTER 2.

INV3702 ASSIGNMENT 1 SEMESTER 2. Investments: Fixed Income Analysis. Which of the following statements is most accurate regarding floating-rate issues that have caps and floors? [1] A cap is an advantage to the bondholder, while a floor is an advantage to the issuer. [2] A floor is an advantage to the bondholder, while a cap is an advantage to the issuer. [3] A floor is an advantage to the issuer and the bondholder, while a cap is a disadvantage to the issuer and the bondholder. A cap is a maximum on the coupon rate and is advantageous to the issuer. A floor is a minimum on the coupon rate and is, therefore advantageous to the bondholder. Textbook reference: 2nd ed. p 14, "X. EMBEDDED OPTIONS" 3rd ed. p 28, “Floating-Rates Notes” Question 2 Which of the following most accurately describes the maximum price for a currently callable bond? [1] its par value [2] the call price [3] the present value of its par value Whenever the price of the bond increases above the strike price stipulated on the call option, it will be optimal for the issuer to call the bond. Theoretically, the price of a currently callable bond should never rise above its call price. Textbook reference: 2nd ed. p 19, "3. The Impact of Embedded Options" 3rd ed. p 35, “5.1 Callable bonds” 3 Question 3 Which one of the following statements about the sinking fund provisions for these bonds is most accurate? [1] The bonds do not have an accelerated sinking fund provision. [2] An investor would benefit from having his bonds called under the provision of the sinking fund. [3] An investor will receive a premium if the bond is redeemed prior to maturity under the provision of the sinking fund. The sinking fund provision does not provide for an acceleration of the sinking fund redemptions. With rates currently below the coupon rate, the bonds will be trading at a premium to par value. Thus, a sinking fund call at par would not benefit the bondholder. Textbook reference: 2nd ed. p 12, "C. Sinking Fund Provision" 3rd ed. p 26, “Sinking fund arrangements” Question 4 A mortgage is least likely … [1] a collateralised loan. [2] subject to early retirement. [3] characterised by highly predictable cash flows. A mortgage can typically be retired early in whole or in part (a prepayment option), and this makes the cash flows difficult to predict with any accuracy. Textbook reference: 2nd ed. p 46, "1. Mortgage Loans" 3rd ed. p 335, “Mortgage loans” 4 Question 5 A bond with a 7.3% yield has a duration of 5.4 and is trading at R985. If the yield decreases to 7.1%, the new bond price is closest to … [1] R 974.40. [2] R 995.64. [3] R1 091.40. The change in yield is 7.3% - 7.1% = 0.2% The percentage price change, based on duration is equal to – 5.4 х ( – 0.2%) = 1.08%. The new price is 1.0108 х 985 = R995.64. Textbook reference: 2nd ed. p 21, "1. Approximate Percentage Price Change" 3rd ed. p 188, “Approximate percentage price change” Question 6 An investor is concerned about interest rate risk. Which one of the following bonds (identical in all other respects) has the least interest rate risk? The bond with … [1] 5% yield and 10-year maturity. [2] 5% yield and 20-year maturity. [3] 6% yield and 10-year maturity.