1.A 12-year, 8 percent annual coupon bond with $100 par value currently sells at par. The bond is callable at 102. What is the effective duration of the bond assuming interest rates change by 100 basis points?
A. 5.85.
B. 7.55.
C. 10.50.
D. 4.58.
2.Political risk is most accurately defined as the:
A. risk that a foreign government, acting in concert with its central bank, will limit or prevent domestic borrowers from repaying debt.
B. relationship between the constitution of a country and the means by which it is enforced.
C. economic and financial risk factors associated with a country as distinctly separate from those of the borrower.
D. risk of loss due to inadequate monitoring systems, management failure, defective controls, fraud, and/or human errors.
3.A primary criticism with the comparative advantage argument as justification for the existence of swaps is related to which of the following?
A. Perceived advantage in one market over the other.
B. Constant spreads over London Interbank Offered Rate (LIBOR).
C. Credit risk.
D. Inefficient credit markets.
4.Immunization is the process of offsetting the effects of interest-rate changes on the value of assets and liabilities. Coverage of liabilities with significant convexity may be more effectively matched with a:
A. Bullet portfolio with little convexity.
B. Callable bond portfolio, especially in a declining-ratc environment.
C. Mortgage portfolio, especially in a highly volatile rate environment.
D. Barbell portfolio with positive convexity.
5.An important step in structuring a securitization is determining an adequate level of credit support or enhancement. Which of the following is not one of common credit enhancement forms for securitization transactions?
A. Subordinated tranches of securitization debt
B. Excess Spread account
C. Cash reserve account
D. Sinking fund account
6.Compared to traditional ways to invest, hedge funds general1y are, as a vehicle for investment:
A. More risky, because they are smaIler and less diversified.
B. Less risky, because they are managed by small, more efficient teams.
C. More risky, because they are more leveraged.
D. Less risky, because they hedge their positions.
Answer:
1.D
Since the bond is selling at par, its yield = coupon rate = 8%.
V0 = Par = 100.
I/Y = 7.00; FV = 100; N = 12; PMT = 0.08 x 100 = 8; PV = V- = 107.94.
Since the call price is 102 which is lower than 107.94, we use V- = 102
I/Y = 9.00; FV = 100; N = 12; PMT = 0.08 x 100 = 8; PV = V+ = 92.84
D = Duration = (V- - V+)/2V0(Δy)
= (102-92.84)/(200x0.01)
= 4.58
2.B
Political risk is the relationship between the constitution of a country and the means by which it is enforced. In some countries, the constitution is held in high esteem, while in others the constitution is used as a vehicle for governments to achieve their goals, not the wants and needs of its citizens.
3.C
Credit risk is the main criticism of the comparative advantage argument, which fails to take into account the fact that a swap participant faces credit risk.
4.D
Barbell portfolios usually contain substantial convexity, which can be used to offset changes in liabilities not met with duration matches.
5.D
Credit enhancements in securitizations protect investors against taking a loss on their securities when losses occur in the underlying asset pool. Credit ehhancements can be structured in different forms including subordinated tranches of securitization debt, excess spread (interest payments and other fees received on the assets in the pool less the interest payments made on the ABS plus the fee paid the service the assets along with other expenses), cash reserve account, and over-collateralization.
D is correct. A sinking fund is a pool of money regularly set aside by a company to redeem its bonds, debentures or preferred stock from time to time as specified in the indenture. A sinking fund is not used a credit enhancement.
6.C
GARP was looking for C as the correct answer. It is true that hedge funds are more highly leveraged than traditional managed portfolios, which makes them more risky.
