Fixed Income Securities
Final Exam Solution
1. Briefly explain why many corporations prefer to issue callable long-term corporate bonds rather than noncallable long-term bonds.
There are three main reasons why a corporation may be interested in calling a bond. * Interest rated have fallen, so they can refinance at a lower rate. * Credit quality has improved, so they can refinance at a lower rate. * Assets have been sold, so money is available to pay off debt.
2. Briefly explain the idea behind an Immunized Bond Portfolio.
With an Immunized Portfolio, the duration and convexity of the assets is set to match the duration and convexity of the liabilities. The PV of the assets is set greater than the …show more content…
There are three primary reasons why Corporate Bonds have a higher yield than Treasury Bonds:
1. Corporate Bonds have default risk 2. Corporate Bonds are taxed differently 3. Corporate Bonds are less liquid
11. Theoretical Spot Rates will be close to Zero Coupon Bond Yields. Explain why there may be small differences in the real world.
There could be slight differences because of frictions in the market caused by transaction costs.
12. Assume the following (all rates are stated annually with semiannual compounding):
a. Six Month Spot Rate is 2.5% b. Six Month Forward rate starting at month six is 2.8% c. Six Month Forward rate starting at month 12 is 3.2%
Then find the price of an 18 month Zero Coupon Bond (Treasury Strip).
There was a common mistakes made on this problem. A few people used these rates as spot rates, rather than forward rates.
13. Name three features that you feel should be included in a Term Structure Model.
There are more than three possible answers. They include:
* Rates should be positive and not get too high * Volatility should be higher when rates are high * Mean Reversion * We should be able to extract forward rates from the model
This is equivalent to saying that treasuries are priced correctly
14. Describe why some bonds are On Special in the