2019 CFA level 3 qbank r 24 25 yield curve str credit str answers

10/12/2018 Learning Management System Question #1 of 19 Je Nordby is a currency trader at a regional investment bank in Baltimore, MD His research department is anticipating a stable yield curve environment for the remainder of the year and Japan's central bank will continue to depress the value of the Yen versus the Dollar for the near future As a result of his team's forecast, Je decides to enter into a Yen carry trade with the U.S dollar The position that Je used to execute his strategy is most likely: in A) Borrowing at the lower Yen rate, converting the Yen to dollars and purchasing U.S Treasuries en tre B) Borrowing at the U.S short-term rate, converting the dollar to Yen and purchasing Yen Gov’t securities C) Borrowing at the higher dollar rate, converting the dollars to Yen and purchasing bo ok c Yen Gov’t securities Explanation o m Prior to the nancial crisis, the Yen-Dollar trade was a very popular carry trade However, since the crisis, most of the developed currencies short- term rates have been very low, which eliminated the carry trade advantage associated with developed market currencies However, it is has become common to borrow in developed currencies, convert the developed currency into under-developed currencies and purchase under-developed government securities to take advantage of the higher interest rates in developing currencies w w (Study Session 12, Module 24.3, LOS 24.c) Related Material w SchweserNotes - Book Question #2 of 19 As a result of the continued global low interest since the nancial crisis of 2008, investors have been investing in larger amounts of emerging market corporate bonds to nd increased yields However, investing in emerging market corporate bonds is very di erent than investing in developed market corporate bonds The following statement correctly identi es these general di erences: https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 1/13 10/12/2018 Learning Management System A) Emerging market bonds have an increased concentration in commodities and banking compared to developed market bonds B) Since the most recent nancial crisis, the developed bond market is overcontrated in government issued bonds as compared to emerging market capital markets as i f b d C) Developed market bonds tend to have lower average credit quality compared to emerging market bonds Explanation (Study Session 12, Module 25.3, LOS 25.g) Related Material Question #3 of 19 bo ok c SchweserNotes - Book en tre in We have seen unprecedented growth in emerging market bonds as investors continue to search for higher yield Compared to developed market bonds, emerging market bonds: tend to be overly concentrated in commodities and banking, are concentrated by emerging market government issued debt and tend to have lower credit quality compared to developed market bonds m Tara Timura is a new xed income analyst for a U.S bond fund She has only been at the rm for a few weeks and has asked to assist the lead portfolio manager in modeling the rm's yield o curve quarterly forecast w w Modeling the yield curve for xed income professionals is complicated because: A) Observations are normally consistent with the neighboring values which helps to w reduce the complexity associated with yield curve modeling B) Gaps in maturities are common and must be interpolated, increasing model complexity C) Luckily, di erences in accounting rarely impact bond prices, so modeling complexity is reduced Explanation The complexity of modeling the yield curve is increased because maturity gaps must be interpolated Also, observations are not always consistent with neighboring values and di erences in accounting rules can impact bond prices dramatically (Study Session 12, Module 24.2, LOS 24.a) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 2/13 10/12/2018 Learning Management System Related Material SchweserNotes - Book Question #4 of 19 Global portfolio managers can often hedge emerging market currency risk by all of the following, except: A) selling currency forwards .in B) selling currency futures Explanation en tre C) swapping the foreign currency for domestic currency of the investor Futures market contracts don't exist for most emerging market currencies so most global portfolio managers use forwards and swaps to hedge currency exposure bo ok c (Study Session 12, Module 25.3, LOS 25.g) Related Material m SchweserNotes - Book o Question #5 of 19 w w Derek Main is a recent college graduate and has been hired as a full-time junior analyst for Falcon Financial, a rm that specializes in providing xed income investment advice to local w pensions Main has been assigned to analyze a newly issued putable bond Main calculates various credit spread measures to begin his analysis The calculated spread measures are as follows: G – Spread 322 I – Spread 325 Z – Spread 334 Main notices that he forgot to calculate an OAS measure, would the OAS be similar to, lower than, or higher than the Z spread measure: https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 3/13 10/12/2018 Learning Management System A) OAS would be lower than the Z spread B) OAS would be higher than the Z Spread C) OAS would be similar to the Z spread Explanation OAS would be higher than the Z-spread because the bond is putable and has favorable redemption features in a rising interest rate environment for the investor (Study Session 12, Module 25.1, LOS 25.b) Related Material en tre in SchweserNotes - Book Question #6 of 19 Laura Timura is the chief risk manager for Quanta Financial, a U.K based consulting rm that bo ok c specializes in risk management strategies for xed income investors A large endowment recently received a signi cant holding in a publicly traded gold mining stock and has hired Quanta to help them hedge this position until they can sell the shares in years Quanta has recommended a hedging strategy to minimize tail risk that most likely includes: m A) selling put options on gold futures contracts .o B) purchasing calls on gold futures w w C) buying credit spread options on the bonds of gold miners they nd least attractively valued w Explanation Quanta most likely would recommend buying put options on gold futures or credit default swaps (CDS) to execute a tail risk hedge (Study Session 12, Module 25.3, LOS 25.f) Related Material SchweserNotes - Book Question #7 of 19 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 4/13 10/12/2018 Learning Management System David Stephen is a Fixed Income Strategist for a large hedge fund After extensive analysis and research, Stephen is predicting an extremely stable yield curve environment for the next few quarters that will remain upward sloping Assuming Stephen's prediction is correct, what active management strategy would Stephen least likely pursue? A) Riding the yield curve B) The carry trade C) Buying convexity by shifting to a barbell strategy Explanation Related Material Question #8 of 19 bo ok c SchweserNotes - Book en tre (Study Session 12, Module 24.3, LOS 24.c) in Assuming Stephen's prediction of a stable yield curve environment, David would need to sell convexity, he would not buy it Convexity can be decreased by buying MBS and callable bonds to increase yield m If a new government bond is issued with a negative coupon rate due to low rates of interest, o the duration of the new bond will: A) not be a ected by its negative coupon rate w w B) be shorter than its maturity w C) be longer than its maturity Explanation If bonds are issued with negative coupon rates, the duration of the bonds will be longer than the maturity (Study Session 12, Module 24.2, LOS 24.a) Related Material SchweserNotes - Book Question #9 of 19 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 5/13 10/12/2018 Learning Management System Bill Mclaughlin is a xed income consultant based in the US Last year, he forecasted very little changes in the yield curve for the next 14 months with a normal yield curve Mclaughlin concentrated his portfolio on 10-Year US Treasury Bonds that had a 2.25% coupon and he purchased his holdings at an average price of 100.38 Mclaughlin expected to sell the bonds in one year at 101.92 Mclaughlin selected the 10-year maturities because they were the steepest part of the yield curve that he could purchase since he was constrained to a 10-year maturity from the IPS At the start of last year, the expected rolling yield on the portfolio was closest to: A) 2.24% .in B) 1.05% Explanation Rolling Yield = Yield Income + Rolldown Return en tre C) 3.74% bo ok c Yield Income = Annual coupon payment / current bond price = $2.25 / $100.38 = 2.24% Rolldown return = (Bond Price End – Bond Price Begin) / Bond Price Begin = $101.92 – $100.38 / $100.38 = 1.5% Rolling Yield = 2.24% + 1.5% = 3.74% Related Material w w o SchweserNotes - Book m (Study Session 12, Module 24.8, LOS 24.i) w Question #10 of 19 Valerie is the investment strategist for a local nancial advisor and is thinking of making tactical changes to her xed income investment model Valerie decides to match the primary risk factor of her target benchmark but also take advantage of an expected increase in yield curvature A) Create a bullet portfolio that is focused on the middle of the yield curve B) Short the barbell and long intermediate-term bonds C) Create a butter y portfolio Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 6/13 10/12/2018 Learning Management System When the yield curve curvature is expected to increase Valerie should use a barbell strategy or a butter y portfolio which is going short intermediate-term bonds and long the barbell (Study Session 12, Module 24.7, LOS 24.h) Related Material SchweserNotes - Book Question #11 of 19 Gerhard Thompson is a xed income PM for a large investment consulting rm based in the US in and has spent the last few weeks analyzing the bond market, speci cally focusing on yield curve en tre forecasting Thompson's forecast is for the yield curve to remain relatively stable for the rst half of the year The investment strategy that Thompson is most likely to follow over the next few months, assuming his forecast is correct, is: A) replacing callable bonds with straight bullet bonds bo ok c B) selling options indirectly by purchasing Mortgage Backed Securities (MBS) C) buying options indirectly by selling MBS Explanation m To reduce convexity, Thompson will purchase MBS MBS have an embedded call option that can be exercised by the home buyer .o Selling MBS securities would increase convexity, not reduce it w w Replacing callable bonds with straight bullet bonds would also increase convexity (Study Session 12, Module 24.5, LOS 24.d) w Related Material SchweserNotes - Book Question #12 of 19 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 7/13 10/12/2018 Learning Management System Randolph David has just won a Request For Proposal to manage a portion of a large multinational corporation's xed income portfolio that totals $25 million David is preparing to implement the portfolio and he is now wondering if he should make a temporary tactical adjustment to take advantage of an expected steepening of the yield curve with a curvature decrease David forecasts partial durations of his original portfolio and his proposed portfolio (see PVBP below) Key Rate PVBPs year year year year 10 year 0049 0061 0135 0136 Tactical Portfolio 0087 0030 0065 0146 in Original Portfolio a curvature decrease is: A) David should select the original portfolio en tre The most optimal portfolio assuming David is correct and the yield curve steepens and also has bo ok c B) David should invest 50% in the original portfolio and 50% in the tactical portfolio C) David should select the tactical portfolio Explanation o m David should execute his original portfolio and not make the tactical changes from his forecasts since the originally proposed portfolio has less partial duration at the ends of the projected key rate durations and increased partial duration in the 3-year and 5-year maturities compared to the tactical portfolio w w (Study Session 12, Module 24.7, LOS 24.f) Related Material w SchweserNotes - Book Question #13 of 19 A credit investor has been conducting extensive research on incorporating ESG considerations into his security selection in the technology sector The investor has created a custom benchmark consisting of corporate technology bonds and his goal is to outperform the benchmark Which credit investment strategy is most appropriate for the credit investor to follow? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 8/13 10/12/2018 Learning Management System A) Top-down approach B) Bottom-up approach C) Multi-factor approach that focuses on predicting economic cycles Explanation A bottom-up approach is more appropriate for this investor The investor has conducted extensive research, including ESG factors into their analysis regarding the technology sector (Study Session 12, Module 25.2, LOS 25.d) Related Material en tre in SchweserNotes - Book Question #14 of 19 Fixed Income Portfolio managers can use butter y spreads to take advantage of changes in bo ok c curvature of the yield curve A butter y spread trade that will pro t from a relative decrease in intermediate rates is: A) long the 2- and 30-Year yield, short the 10-Year yield B) short the 2- and 10-Year yield, long the 30-Year yield o Explanation m C) short the 2- and 30-Year yield, long the 10-Year yield w w w A butter y spread measures the di erential in intermediate versus longer and shorter rates A butter y trade is long (or short) intermediate (bullet) duration and short (or long) an equivalent weighted average duration combination of shorter and longer duration (barbell) bonds With an expected relative decline in intermediate rates you will want a long position in the intermediate (in this case 10-year) bond to capture its relative price appreciation One of the other choices does not meet the de nition of long and short a bullet and barbell The other does meet the de nition but shorting the intermediate position pro ts if intermediate rates increase (Study Session 12, Module 24.2, LOS 24.a) Related Material SchweserNotes - Book Question #15 of 19 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 9/13 10/12/2018 Learning Management System Sunil Ranieel is an investment-grade xed income investment strategist for a large pension fund based in the UK Ranieel was at a recent luncheon and was describing his investment process to some local college students at his lunch table Ranieel's investment process will primarily be focused on: A) collateral valuation B) interest rates C) debt covenants Explanation Related Material Question #16 of 19 bo ok c SchweserNotes - Book en tre (Study Session 12, Module 25.1, LOS 25.a) in An investment grade portfolio manager would focus on interest rates and interest rate risks and would not emphasize debt covenants and collateral valuation because investment grade bonds have high credit evaluation metrics m There are potential bene ts for a corporate bond portfolio manager to include CDOs in their o portfolio except: A) relative value opportunities w w B) diversi cation w C) leverage opportunities Explanation The collateral for a CDO is frequently corporate bonds, so there is little diversi cation bene ts for a corporate bond portfolio manager to include CDOs in their portfolio (Study Session 12, Module 25.4, LOS 25.h) Related Material SchweserNotes - Book Question #17 of 19 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 10/13 10/12/2018 Learning Management System Bid-ask spreads have historically been used to assess liquidity in xed income markets However, this indicator has proven to be less reliable primarily because: A) of increased assets under management in Fixed-Income ETFs B) of reduced spread sensitivity to fund out ows C) bond dealers and brokers generally hold much less inventory than in the past because of regulatory and capital constraints Explanation As a result of regulatory and capital requirements, bond dealers/brokers now hold less inventory that traditionally provided market liquidity .in (Study Session 12, Module 25.3, LOS 25.e) en tre Related Material Question #18 of 19 bo ok c SchweserNotes - Book Susan Walrad has currently been hired as a summer intern for a prestigious investment bank and wants to impress her boss Susan learns that her boss, Ted, is currently preparing for an m upcoming meeting with one of their top clients to discuss the performance of bullet and barbell investment strategies under di erent yield curve scenarios Susan talks with Ted and learns o that Ted is going to recommend an investment strategy that works best in an increased interest w w rate volatility environment The strategy that Ted would most likely select: w A) a barbell strategy consisting of buying 5-year and 20-year Treasury government bonds B) a carry trade C) a bullet strategy that will only purchase a 10-Year Treasury government bond Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 11/13 10/12/2018 Learning Management System A barbell strategy will generally outperform in an increased interest rate volatility environment and a bullet strategy will generally underperform in this environment (see table below) Relative Performance of Bullets and Barbells under Di erent Yield Curve Scenarios Yield Curve Scenario Barbell Bullet Level change Parallel shift Outperforms Underperforms Slope change Flattening Outperforms Underperforms Steepening Underperforms Outperforms Less curvature Underperforms Outperforms More curvature Outperforms Decreased rate volatility Underperforms Outperforms Increased rate volatility Outperforms Underperforms bo ok c (Study Session 12, Module 24.6, LOS 24.e) in Rate volatility change Underperforms en tre Curvature change Related Material m SchweserNotes - Book o Question #19 of 19 w w A bond portfolio manager using the bottom-up approach to security selection would most likely begin their analysis by focusing on: w A) bonds that have comparable credit risk B) average credit spreads C) macro factors that drive interest rates Explanation Bottom-up credit analysis is most appropriate for analyzing securities that have similar credit risk (Study Session 12, Module 25.2, LOS 25.c) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 12/13 Learning Management System w w w o m bo ok c en tre in 10/12/2018 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83450560/print 13/13 ... Outperforms Underperforms Steepening Underperforms Outperforms Less curvature Underperforms Outperforms More curvature Outperforms Decreased rate volatility Underperforms Outperforms Increased rate... Performance of Bullets and Barbells under Di erent Yield Curve Scenarios Yield Curve Scenario Barbell Bullet Level change Parallel shift Outperforms Underperforms Slope change Flattening Outperforms... 30 -Year yield, short the 10-Year yield B) short the 2- and 10-Year yield, long the 30 -Year yield o Explanation m C) short the 2- and 30 -Year yield, long the 10-Year yield w w w A butter y spread