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FIXED INCOME QUESTION HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 21 MINUTES Rob Watson, CFA, manages numerous bond portfolios Selected information for one of his portfolios and the benchmark index used to evaluate the portfolio are provided below Bond Portfolio A Index Active return 0.36% N/A Active risk 0.40% N/A Average duration 4.6 5.0 Average % weighting in industrial sector 31% 27% Average % weighting in utilities sector 14% 17% Average % weighting in investment grade 73% 78% Relative portfolio turnover moderate low A Determine whether Portfolio A’s total return mandate is enhanced indexing or active management Support your decision with two reasons (5 minutes) The following information prepared by one of Watson’s quantitative analysts, pertains to another portfolio, Bond Portfolio B The projected bond prices included in the table assume the yield curve remains unchanged Watson wants to use the data to calculate projected return Average annual coupon rate Coupon frequency Percentage of portfolio invested in foreign bonds Percentage of portfolio bond value projected to default Loss given default Projected average yield and spread change of portfolio Projected average depreciation of foreign currencies Current average bond price of portfolio Projected average bond price in months Projected average bond price in one year Average bond convexity of portfolio Average bond duration (modified duration) of portfolio Average bond effective duration of portfolio 4.5% Semiannual 30% 0.12% 80% –0.37% 2.55% 100.97 100.90 100.81 2.74 7.5 6.9 B Calculate the projected return for Portfolio B for a six month holding period Show your calculations (6 minutes) Watson is reviewing the following two statements made by his assistant: The correlation of returns between government bonds and riskier assets tends to increase during periods of market stress With floating-coupon bonds, both the interest and principal are directly protected from inflation For each statement above, determine whether the statement is correct or incorrect If incorrect, justify your determination with one reason Answer the question in the template provided (6 minutes) Template for Part C Statement Determine whether the statement is correct or incorrect (circle one) The correlation of returns between government bonds and riskier assets tends to increase during periods of market stress Correct With floating-coupon bonds, both the interest and principal are directly protected from inflation Incorrect Correct Incorrect If incorrect, justify your determination with one reason Watson has recently hired a new assistant The assistant is familiar with stock trading and surprised how much more difficult it is to trade corporate bonds Watson explains that dealer markets and over-the-counter (OTC) trading in the corporate bond market are a contributing factor to this lack of liquidity C Explain two reasons why dealer markets and OTC trading of bonds contributes to lower liquidity in the corporate bond market (4 minutes) QUESTION HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 17 MINUTES Eva Toth, CFA, manages bond portfolios with a wide range of underlying bond maturities; using a combination of investment-grade (IG) and high-yield (HY) bonds She is working with her firm’s marketing group and has been asked to provide background information for clients on three issues: Relative price sensitivity of HY and IG bonds to changes in spread and risk-free rates Relative liquidity of IG and HY bonds and the effect on portfolio turnover The relative merits of I-spread and G-spread A State whether HY bond prices have greater sensitivity to spread change or changes in riskfree rates Justify your response with one reason (3 minutes) B State whether turnover in HY portfolios is likely to be higher or lower compared to IG portfolios Justify your response with one reason (3 minutes) C Discuss two reasons why the I-spread cannot be used as a direct substitute for the G-spread (4 minutes) Next, Toth reviews the following information on two bonds, one of which she will short sell for a period of six months Bond Yield Z-spread Spread duration Default rate* 4.25% 175bp 0.43% 4.75% 240bp 0.54% * Annualized default rate with loss given default of 65% D Select the best bond for Toth to short sell for a six month period, assuming all spreads widen by 50bp Justify your selection Show your calculations (4 minutes) Lastly, Toth reviews information on three additional bonds, all of which are similar to each other with the exception of optionality One of the bonds is option free, one is callable and one is putable Toth believes that interest rate volatility will increase significantly in the near term and that this is not reflected in market consensus views Bond G-spread I-spread Z-spread OAS 330 334 339 402 332 336 342 342 335 338 343 271 E Select the bond Toth will purchase to profit from her expectation that interest rate volatility will increase significantly in the near term and justify your selection (3 minutes) ... not reflected in market consensus views Bond G-spread I-spread Z-spread OAS 33 0 33 4 33 9 402 33 2 33 6 34 2 34 2 33 5 33 8 34 3 271 E Select the bond Toth will purchase to profit from her expectation that... lower liquidity in the corporate bond market (4 minutes) QUESTION HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 17 MINUTES Eva Toth, CFA, manages bond portfolios with a wide range of underlying... response with one reason (3 minutes) B State whether turnover in HY portfolios is likely to be higher or lower compared to IG portfolios Justify your response with one reason (3 minutes) C Discuss
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