Reading 23 Yield Curve Strategies FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session 11 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 23 Yield Curve Strategies FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 23: Yield Curve Strategies Question ID: 134616 Correct Answer: B B is correct The leverage required under Strategy A is calculated as follows: Required additional PVBP ÷ Duration of bonds to be purchased and financed × 10,000 = Required leverage $5,000 6.00 × 10,000 = $8,333,333 Question ID: 134617 Correct Answer: A A is correct Tyson is correct regarding the additional risks associated with Strategy A Leverage adds interest rate risk because it increases the portfolio’s sensitivity to changes in interest rates Furthermore, because the bonds comprising Tyson’s portfolio contain credit risk (as evidenced by the below investment grade credit rating), leverage will amplify both credit risk and liquidity risk Question ID: 134618 Correct Answer: B B is correct Adding a receive-fixed/pay floating swap to the existing portfolio will lengthen duration because the fixed position has a greater and positive duration compared to the smaller and negative duration of the floating position A is incorrect A pay-fixed swap will be employed in the situation when duration is required to be shortened FinQuiz.com © 2018 - All rights reserved Reading 23 Yield Curve Strategies FinQuiz.com Question ID: 134619 Correct Answer: B B is correct Because Knight projects higher interest rate volatility and more curvature in the yield curve (as evidenced by the increase in butterfly spread), a barbell portfolio will outperform the bullet and laddered portfolios 30-year Treasuries will increase in value given the drop in the 30-year yields On the other hand, even though the increase in 2-year yields is higher than the increase in 5-year yields, the decline in value of 2-Year Treasuries should not be significant because these securities will have the lowest interest rate sensitivity based on a low duration measured compared to securities from other maturity sectors A bullet portfolio comprising 10-year Treasuries will not change in value and will underperform a barbell portfolio A laddered portfolio will underperform a barbell given that it comprises a combination of securities which decrease in value (2- and 5-year Treasuries), remain unchanged (10-Year Treasuries) and increase in value (30-Year Treasuries) Furthermore, the weight allocated to the outperforming 30Year Treasuries is considerably lower to that of the barbell (25% versus 50%, respectively) which further reduces contribution to portfolio performance Question ID: 134620 Correct Answer: C C is correct When the market is concerned about extreme interest rate movements (in the form of higher interest rate volatility) but is uncertain of the direction of the change, the cost of adding convexity – option premiums – can be very high A is incorrect Call options are purchased by investors who desire to increase portfolio convexity This strategy is profitable when interest rate volatility is high, and the option has a higher chance of becoming in-the-money On the other hand, convexity is sold when interest rates are not expected to move significantly (interest rate volatility is low) and the manager sells During such circumstances convexity is sold because it is viewed as being overpriced B is incorrect Yield premium is earned by the seller of an option Question ID: 134621 Correct Answer: B B is correct Tyson is accurate regarding Statement but inaccurate regarding Statement Barbell portfolios have higher convexity compared to bullet portfolios because the former include securities with longer maturities In this scenario, barbell portfolios will have greater sensitivity to interest rate movements and will increase more in value for a downward parallel yield curve shift and will decrease less in value for an upward parallel yield curve shift compared to the lower convexity bullet Statement is incorrect Nonparallel yield curve shifts include twists and shifts in the yield An increase in curvature and yield curve flattening will favor a barbell portfolio to a bullet portfolio as the former will outperform the latter On the other hand, a decrease in curvature and yield curve steepening will favor a bullet portfolio to a barbell portfolio as the former will outperform the latter Therefore, there is no single defined portfolio which will outperform when yield curve shifts are nonparallel FinQuiz.com © 2018 - All rights reserved .. .Reading 23 Yield Curve Strategies FinQuiz. com FinQuiz Level III 2018 – Item- sets Solution Reading 23: Yield Curve Strategies Question ID: 134 616 Correct Answer: B B... follows: Required additional PVBP ÷ Duration of bonds to be purchased and financed × 10,000 = Required leverage $5,000 6.00 × 10,000 = $8 ,33 3 ,33 3 Question ID: 134 617 Correct Answer: A A is correct Tyson... situation when duration is required to be shortened FinQuiz. com © 2018 - All rights reserved Reading 23 Yield Curve Strategies FinQuiz. com Question ID: 134 619 Correct Answer: B B is correct Because