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INV3702+May- June+2013+Exam+Memo
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INV3702+May-June+2013+Exam+Memo
, 2
INV3702
May/June 2013
SECTION A: MULTIPLE CHOICE QUESTIONS (40 MARKS)
1. All else equal, which of the following would most likely increase the yield to maturity
on a debt security?
1. Put option.
2. Conversion option.
3. Negative covenants.
4. Cap on a floating-rate security.
A cap on a floating-rate secutity is an embedded option that favours the issuer, not the
buyer, so buyers will would demand a higher YTM for a bond with such a feature. The
other alternatives favour the buyer and decrease the YTM that buyers require.
2. One year ago, an investor purchased a 10-year, R1,000 par value, 8% semiannual
coupon bond with an 8% yield to maturity. Today interest rates remain unchanged at
8%. If the investor sells the bond today (immediately after receiving the second
coupon payment, and with no transaction costs), he will have:
1. a capital loss of R80.
2. a capital gain of R80.
3. no capital gain or loss.
4. a capital gain of R1,080.
One year ago (when he bought the bond) the coupon rate was equal to the YTM, so
the bond would have traded at par. Now (one year later), with interest rates
unchanged, the bond will still sell at par. There would therefore be no capital gain or
loss from the sale.
3. A 15-year, 8% semiannual-pay bond has a par value of R10,000. If it were priced to
yield 7.4%, this bond would be trading for:
1. R10,523.
2. R10,528.
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INV3702
May/June 2013
3. R10,533.
4. R10,538.
30 N
3.7 I/YR
10000 FV
400 PMT
PV = 10,538
4. The price of a 5-year zero coupon bond with a current yield to maturity (YTM) of 8.4%
is 66.27. If the YTM increases to 8.9%, the price will decrease to 64.70. If the YTM
decreases to 7.9%, the price will increase to 67.88. The effective duration is closest
to:
1. 2.40.
2. 3.18.
3. 4.80.
4. 5.38.
Effective duration = (67.88 – 64.70)÷(66.27 x 2 x 0.005) = 4.80
(Price changes are based on 50 basis point change in yield)
5. Which of the following statements about the risks associated with investing in bonds is
least accurate?
1. If the issuer/borrower prepays, the holder of the bond has reinvestment risk.
2. Credit risk is the risk that an investor will be unable to sell the security quickly and
at a fair price.
3. Volatility risk is the risk that the price of a bond with an embedded option will
decline when expected yield volatility changes.
4. Interest rate risk is the risk that a bondholder faces if the price of a bond held in a
portfolio will decline due to rising market interest rates.
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