CFA level 3 CFA level 3 volume III applications of economic analysis and asset allocation finquiz item set answers, study session 12, reading 22

Reading 22 Liability-Driven and Index-Based Strategies FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session 10 June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading 22 Liability-Driven and Index-Based Strategies FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 22: Liability-Driven and Index-Based Strategies Question ID: 134577 Correct Answer: C C is correct The residential mortgage loan is an example of a Type IV asset to Lake’s lender because the prepayment option may result in coupon interest and principal being received earlier than expected increasing the uncertainty for the mortgage lender In addition, the potential for default exists and affects the projected amount of cash flow at each date Type IV liabilities/assets have an uncertain timing and amount Question ID: 134578 Correct Answer: C C is correct Strong’s instructions to Mendes regarding immunizing Lake’s liability are inappropriate because she has failed to consider the fact that the duration measure changes with the passage of time and shifts in yield curve A is incorrect A sufficient, but not necessary, condition for immunization is that yield curve shifts are parallel However, the immunization conditions can even prevail in the event of non-parallel yield curve shifts B is incorrect Mortgage loans are an example of a Type IV liability and therefore effective duration should be used to measure interest rate sensitivity Strong has appropriately instructed Mendes to match the effective durations and market value of the asset and liability portfolios Question ID: 134579 Correct Answer: B B is correct To immunize a multi-liability portfolio 1) the BPV of the asset portfolio should closely match that of the liability portfolio and 2) the asset portfolio should have a higher dispersion (which can be implied as higher convexity) The BPVs of all three asset portfolios closely match the liabilities portfolio To immunize multiple liabilities using duration matching, the convexity of the asset portfolio should be higher Portfolio A and C are ruled out on these grounds which makes Portfolio B the most optimal choice FinQuiz.com © 2018 - All rights reserved Reading 22 Liability-Driven and Index-Based Strategies FinQuiz.com Question ID: 134580 Correct Answer: B B is correct A laddered portfolio such as Portfolio C is optimal for liquidity management because as time passes there will always be a bond that is close to redemption With a greater range of bonds of varying maturities, the final coupon and principal of bonds can be deployed for consumption or reinvested in a long-term bond at the back of the ladder A is incorrect Structural risk arises from the design of the asset portfolio The more dispersed a portfolio’s cash flows are, the higher is the structural risk In this respect, Portfolio C has the highest cash flow dispersion and has the highest structural risk while Portfolio A has the lowest amount of structural risk Question ID: 134581 Correct Answer: A A is correct One of the drawbacks of immunizing multiple Type I liabilities such as those of Wholesome Foods’ with assets of higher quality (A-rated versus AAA-rated, respectively), is that the exposure to spread risk increases The risk is that the respective spreads on the asset and liability portfolios not move in unison with a shift in the benchmark bond yield curve Question ID: 134582 Correct Answer: B Strong will prefer the purchase of the receiver swaption over the other two derivatives contracts when the swap rate exceeds 5.50% In this scenario, the swaption collar will generate a loss to Wholesome Foods because the payer swaption will be in the money for the counterparty (and will require a payment to the counterparty) while the receiver swaption will be out of the money The receive-fixed swap will also be unfavorable because it incurs a loss while the purchased receiver swaption will help mitigate the loss which is generated on the two overlay strategies FinQuiz.com © 2018 - All rights reserved  .. .Reading 22 Liability-Driven and Index-Based Strategies FinQuiz. com FinQuiz Level III 2018 – Item- sets Solution Reading 22: Liability-Driven and Index-Based Strategies Question ID: 134 577... effective durations and market value of the asset and liability portfolios Question ID: 134 579 Correct Answer: B B is correct To immunize a multi-liability portfolio 1) the BPV of the asset portfolio... amount of structural risk Question ID: 134 581 Correct Answer: A A is correct One of the drawbacks of immunizing multiple Type I liabilities such as those of Wholesome Foods’ with assets of higher