fixed income test 3 (Answered) Complete
Solution
delta
first-order sensitivity to the price of the underlying asset; positive for calls and increase
with moneyness, negative for puts and decrease with moneyness
gamma
measures how delta changes as spot price increases
theta
measures time decay of an options value; always negative for calls, usually negative for
puts
vega
sensitivity of an options price to changes in volatility of the underlying asset
rho
sensitivity of an option price to changes in the risk free rate (r); positive for calls,
negative for puts
bullet bond
bond in which the principal repayment is made entirely at maturity
plain vanilla bond
bond that makes periodic, fixed coupon payments during the bond's life and a lump-sum
payment of principal at maturity
fully amortized bond
bond where principal is repaid gradually by maturity; similar to sinking fund
credit risk
risk of default; non-agency RMBS and credit card RBS have this
interest rate risk
aka price fluctuation risk; changes in rate could affect value of bond
liquidity risk
a less severe form of credit risk
reinvestment rate risk
risk that CFs will have to be reinvested at a lower rate
contraction risk
risk that prepayment speed will increase; happens when interest rates decrease and
people refinance homes
extension risk
risk that prepayment speed will decrease; happens when interest rates increase and
people stay in their homes
balloon risk
risk that the borrower will not be able to make lump sum payment at maturity
prepayment risk
the risk that mortgages underlying a agency-backed security/pass-through will be paid
off sooner than expected due to a drop in interest rates
local expectations theory
theory that bond maturity does not influence returns for short holding periods
liquidity preference theory
Solution
delta
first-order sensitivity to the price of the underlying asset; positive for calls and increase
with moneyness, negative for puts and decrease with moneyness
gamma
measures how delta changes as spot price increases
theta
measures time decay of an options value; always negative for calls, usually negative for
puts
vega
sensitivity of an options price to changes in volatility of the underlying asset
rho
sensitivity of an option price to changes in the risk free rate (r); positive for calls,
negative for puts
bullet bond
bond in which the principal repayment is made entirely at maturity
plain vanilla bond
bond that makes periodic, fixed coupon payments during the bond's life and a lump-sum
payment of principal at maturity
fully amortized bond
bond where principal is repaid gradually by maturity; similar to sinking fund
credit risk
risk of default; non-agency RMBS and credit card RBS have this
interest rate risk
aka price fluctuation risk; changes in rate could affect value of bond
liquidity risk
a less severe form of credit risk
reinvestment rate risk
risk that CFs will have to be reinvested at a lower rate
contraction risk
risk that prepayment speed will increase; happens when interest rates decrease and
people refinance homes
extension risk
risk that prepayment speed will decrease; happens when interest rates increase and
people stay in their homes
balloon risk
risk that the borrower will not be able to make lump sum payment at maturity
prepayment risk
the risk that mortgages underlying a agency-backed security/pass-through will be paid
off sooner than expected due to a drop in interest rates
local expectations theory
theory that bond maturity does not influence returns for short holding periods
liquidity preference theory
