Chapter 6: The Domestic and International Bond Market

1. A hedge fund has borrowed Company A’s bonds and sold them short and used the proceeds to purchase Company B’s bonds. The fund believes the bonds to be of equal risk but Company A’s bond was yielding 6% while Company B’s bond was yielding 8%. This is an example of:

speculation hedging arbitrage diversification

2. A bond provision that allows the issuer to repurchase the bond from investors at a specified price is known as a:

warrant provision call provision convertible provision collateral provision

3. The Macaulay duration of a bond is 5.5 years. If the yield falls from 13% to 12% the bond price will:

fall by approximately 5.5% fall by approximately 4.9% rise by approximately 5.5% rise by approximately 4.9%

4. You are given the following data concerning the following 5 years to maturity corporate bonds.

Company Bond	Rating	Yield to Maturity
Company A	AAA	8%
Company B	BBB	10%

According to your analysis, the normal yield spread between AAA and BBB bonds should be 150 basis points. You decide to adopt a strategy to maximise profits from a return to the normal spread. The strategy to do this is:

Buy Company A bonds. Buy Company B bonds. Short sell Company A bonds and use the proceeds to buy Company B bonds. Short sell Company B bonds and use the proceeds to buy Company A bonds.

5. Which of the following statements regarding Macaulay duration is true?

The duration of a coupon bearing bond will always be greater than its term to maturity. Other things being equal, the larger the coupon rate on a bond the greater its duration. The longer the duration of a bond the greater will be its price rise for any given rise in interest rates. Other things being equal a bond’s duration is inversely related to its yield to maturity.

6. If you are expecting yields to rise by 2% across all maturities which of the following bonds will fall by the least in price:

A 10% coupon bond with 15 years to maturity. A 5% coupon bond with 15 years to maturity. A 10% coupon bond with 20 years to maturity. A 5% coupon bond with 20 years to maturity.

7. Bond A has a modified duration of 5 years and bond B has a modified duration of 8 years, the yield curve is flat with interest rates a 7% across all maturities. A portfolio of £10 million worth of bonds made up of 50% of bond A and 50% of bond B will be worth approximately which of the following if interest rates fall to 6% across all maturities:

£10,650,000 £10,607, 477 £9,350,000 £9,392,523

8. You have the following information on three bonds:

	Credit Rating	Modified duration	Yield to maturity
Bond A	AAA	5 Years	6%
Bond B	AA	5 Years	7%
Bond C	A	5 Years	8.5%

You believe that the correct spread between AAA and AA bonds should be 60 basis points and between AA and A bonds should be 70 basis points. The profit maximising strategy you should adopt is:

Buy bond A, short sell Bond B and short sell Bond C. Short sell bond A, buy Bond B and short sell Bond C Buy bond A, short sell Bond B and buy Bond C Short sell bond A, buy Bond B and buy Bond C

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