Managing Bond Portfolios Answer Key 1

Chapter 16 - Managing Bond Portfolios Chapter 16 Managing Bond Portfolios Answer Key Multiple Choice Questions 1. The duration of a bond is a function of the bond's A. coupon rate. B. yield to maturity. C. time to maturity. D. All of these are correct. E. None of these is correct. Duration is calculated by discounting the bond's cash flows at the bond's yield to maturity and, except for zero-coupon bonds, is always less than time to maturity. 2. Ceteris paribus, the duration of a bond is positively correlated with the bond's A. time to maturity. B. coupon rate. C. yield to maturity. D. All of these are correct. E. None of these is correct. Duration is negatively correlated with coupon rate and yield to maturity. Chapter 16 - Managing Bond Portfolios 3. Ceteris paribus, the duration of a bond is negatively correlated with the bond's A. time to maturity. B. coupon rate. C. yield to maturity. D. coupon rate and yield to maturity. E. None of these is correct. Duration is negatively correlated with coupon rate and yield to maturity. 4. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is lower. D. current yield is higher. E. None of these is correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). Chapter 16 - Managing Bond Portfolios 5. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is higher. B. coupon rate is higher. C. yield to maturity is higher. D. All of these are correct. E. None of these is correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). 6. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is lower. B. coupon rate is lower. C. yield to maturity is higher. D. term-to-maturity is lower and yield to maturity is higher. E. None of these is correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). Chapter 16 - Managing Bond Portfolios 7. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is lower. D. term-to-maturity is lower and coupon rate is higher. E. All of these are correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). 8. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is higher. D. term-to-maturity is lower and coupon rate is higher. E. All of these are correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). Chapter 16 - Managing Bond Portfolios 9. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is higher. B. coupon rate is lower. C. yield to maturity is higher. D. term-to-maturity is higher and coupon rate is lower. E. All of these are correct. The longer the maturity, the greater the interest-rate risk. The lower the coupon rate, the greater the interest-rate risk. The lower the yield to maturity, the greater the interest-rate risk. These concepts are reflected in the duration rules; duration is a measure of bond price sensitivity to interest rate changes (interest-rate risk). 10. The "modified duration" used by practitioners is equal to the Macaulay duration A. times the change in interest rate. B. times (one plus the bond's yield to maturity). C. divided by (one minus the bond's yield to maturity). D. divided by (one plus the bond's yield to maturity). E. None of these is correct. D* = D/(1 + y) Chapter 16 - Managing Bond Portfolios 11. The "modified duration" used by practitioners is equal to ______ divided by (one plus the bond's yield to maturity). A. current yield B. the Macaulay duration C. yield to call D. yield to maturity E. None of these is correct. D* = D/(1 + y) 12. Given the time to maturity, the duration of a zero-coupon bond is higher when the discount rate is A. higher. B. lower. C. equal to the risk free rate. D. The bond's duration is independent of the discount rate. E. None of these is correct. The duration of a zero-coupon bond is equal to the maturity of the bond. Chapter 16 - Managing Bond Portfolios 13. The interest-rate risk of a bond is A. the risk related to the possibility of bankruptcy of the bond's issuer. B. the risk that arises from the uncertainty of the bond's return caused by changes in interest rates. C. the unsystematic risk caused by factors unique in the bond. D. the risk related to the possibility of bankruptcy of the bond's issuer and the risk that arises from the uncertainty of the bond's return caused by changes in interest rates. E. All of these are correct. Changing interest rates change the bond's return, both in terms of the price of the bond and the reinvestment of coupon payments. 14. Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, X, with a 5-year-to-maturity and a 10% coupon rate. 2) A zero-coupon bond, Y, with a 5-year-to-maturity and a 10% yield-to-maturity. A. Bond X because of the higher yield to maturity. B. Bond X because of the longer time to maturity. C. Bond Y because of the longer duration. D. Both have the same sensitivity because both have the same yield to maturity. E. None of these is correct. Duration is the best measure of bond price sensitivity; the longer the duration the higher the price sensitivity. Bond Y has a longer duration. Chapter 16 - Managing Bond Portfolios 15. Holding other factors constant, which one of the following bonds has the smallest price volatility? A. 5-year, 0% coupon bond B. 5-year, 12% coupon bond C. 5 year, 14% coupon bond D. 5-year, 10% coupon bond E. Cannot tell from the information given. Duration (and thus price volatility) is lower when the coupon rates are higher. 16. Which of the following is not true? A. Holding other things constant, the duration of a bond increases with time to maturity. B. Given time to maturity, the duration of a zero-coupon decreases with yield to maturity. C. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower. D. Duration is a better measure of price sensitivity to interest rate changes than is time to maturity. E. All of these are correct. The duration of a zero-coupon bond is equal to time to maturity, and is independent of yield to maturity. Chapter 16 - Managing Bond Portfolios 17. Which of the following is true? A. Holding other things constant, the duration of a bond decreases with time to maturity. B. Given time to maturity, the duration of a zero-coupon increases with yield to maturity. C. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower. D. Duration is a better measure of price sensitivity to interest rate changes than is time to maturity. E. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower, and duration is a better measure of price sensitivity to interest rate changes than is time to maturity. The duration of a zero-coupon bond is equal to time to maturity, and is independent of yield to maturity. 18. The duration of a 5-year zero-coupon bond is A. smaller than 5. B. larger than 5. C. equal to 5. D. equal to that of a 5-year 10% coupon bond. E. None of these is correct. Duration of a zero-coupon bond equals the bond's maturity. Chapter 16 - Managing Bond Portfolios 19. The basic purpose of immunization is to A. eliminate default risk. B. produce a zero net interest-rate risk. C. offset price and reinvestment risk. D. eliminate default risk and produce a zero net interest-rate risk. E. produce a zero net interest-rate risk and offset price and reinvestment risk. When a portfolio is immunized, price risk and reinvestment risk exactly offset each other resulting in zero net interest-rate risk. 20. The duration of a par value bond with a coupon rate of 8% and a remaining time to maturity of 5 years is A. 5 years. B. 5.4 years. C. 4.17 years. D. 4.31 years. E. None of these is correct. Calculations are shown below.