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Fixedincome
CFA二级原版书课后题
1-386
Reading32
TheTermStructureandInterestRateDynamics
2-386
Example
Aone-yearzero-couponbondyields4.0%.Thetwo-andthree-yearzero-
couponbondsyield5.0%and6.0%respectively.
3-386
Example
Therateforaone-yearloanbeginninginoneyearisclosestto:
A.4.5%.
B.5.0%.
C.6.0%.
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Example
Answer:C
Fromtheforwardratemodel,wehave
=[1+r(1)]1[1+f(1,1)]1
[1+r(2)]2
Usingtheone-andtwo-yearspotrates,wehave
(1+0.05)2
(1+0.04)
(1+.05)2
=(1+.04)1[1+f(1,1)]1,so
−1
=f(1,1)=6.010%
5-386
Example
Theforwardrateforatwo-yearloanbeginninginoneyearisclosestto:
A.5.0%
B.6.0%
C.7.0%
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Example
Answer:C
Fromtheforwardratemodel,
=[1+r(1)]1[1+f(1,2)]2
[1+r(3)]3
Usingtheoneandthree-yearspotrates,wefind
(1+0.06)3
(1+0.04)
(1+0.06)3
=(1+0.04)1[1+f(1,2)]2,so
−1
=f(1,2)=7.014%
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Example
Theforwardrateforaone-yearloanbeginningintwoyearsisclosestto:
A.6.0%
B.7.0%
C.8.0%
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Example
Answer:C
Fromtheforwardratemodel,
=[1+r(2)]2[1+f(2,1)]1
[1+r(3)]3
Usingthetwoandthree-yearspotrates,wefind
(1+0.06)3
(1+0.05)
(1+0.06)3
=(1+0.05)2[1+f(2,1)]1,so
−1
=f(2,1)=8.029%
9-386
Example
Thefive-yearspotrateisnotgivenabove;however,theforwardpriceforatwo-
yearzero-couponbondbeginninginthreeyearsisknowntobe0.8479.The
pricetodayofafive-yearzero-couponbondisclosestto:
A.0.7119.
B.0.7835.
C.0.9524.
10-386
Example
Answer:A
WecanconvertspotratestospotpricestofindP(3)==0.8396.The
forwardpricingmodelcanbeusedtofindthepriceofthefive-yearzeroas
P(T*+T)=P(T*)F(T*,T),soP(5)=P(3)F(3,2)=0.8396×0.8479=0.7119.
11-386
Example
Theone-yearspotrater(1)=4%,theforwardrateforaone-yearloan
beginninginoneyearis6%,andtheforwardrateforaone-yearloanbeginning
intwoyearsis8%.Whichofthefollowingratesisclosesttothethree-yearspot
rate?
A.4.0%
B.6.0%
C.8.0%
12-386
Example
Answer:B
Applyingtheforwardratemodel,wefind
[1+r(3)]3
=[1+r(1)]1[1+f(1,1)]1[1+f(2,1)]1
So[1+r(3)]3
=(1+0.04)1(1+0.06)1(1+0.08)1,
3
1.19063
=r(3)=5.987%.
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Example
Theone-yearspotrater(1)=5%andtheforwardpriceforaone-yearzero-
couponbondbeginninginoneyearis0.9346.Thespotpriceofatwo-year
zero-couponbondisclosestto:
A.0.87.
B.0.89.
C.0.93.
14-386
Example
Answer:B
Wecanconvertspotratestospotpricesandusetheforwardpricingmodel,
sohaveP(1)=1=0.9524.TheforwardpricingmodelisP(T*+T)=
1.05
P(T*)F(T*,T)soP(2)=P(1)F(1,1)=0.9524×0.9346=0.8901.
15-386
Example
Inatypicalinterestrateswapcontract,theswaprateisbestdescribedasthe
interestrateforthe:
A.fixed-ratelegoftheswap.
B.floating-ratelegoftheswap.
C.differencebetweenthefixedandfloatinglegsoftheswap.
16-386
Example
Answer:A
Theswaprateistheinterestrateforthefixed-ratelegofaninterestrate
swap.
17-386
Example
Atwo-yearfixed-for-floatingLiborswapis1.00%andthetwo-yearUSTreasury
bondisyielding0.63%.Theswapspreadisclosestto:
A.37bps.
B.100bps.
C.163bps.
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Example
Answer:A
Theswapspread=1.00%−0.63%=0.37%or37bps.
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Example
Theswapspreadisquotedas50bps.Ifthefive-yearUSTreasurybondis
yielding2%,theratepaidbythefixedpayerinafive-yearinterestrateswapis
closestto:
A.0.50%.
B.1.50%.
C.2.50%.
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Example
Answer:C
Thefixedlegofthefive-yearfixed-for-floatingswapwillbeequaltothe
five-yearTreasuryrateplustheswapspread:2%+0.5%=2.5%.
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Example
Ifthethree-monthT-billratedropsandtheLiborrateremainsthesame,the
relevantTEDspread:
A.increases.
B.decreases.
C.doesnotchange.
22-386
Example
Answer:A
TheTEDspreadisthedifferencebetweenthethree-monthLiborrateand
thethree-monthTreasurybillrate.IftheT-billratefallsandLibordoesnot
change,theTEDspreadwillincrease.
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Example
GiventheyieldcurveforUSTreasuryzero-couponbonds,whichspreadismost
helpfulpricingacorporatebond?The:
A.Z-Spread.
B.TEDspread.
C.Libor–OISspread.
24-386
Example
Answer:A
TheZ-spreadisthesingleratewhich,whenaddedtotheratesofthespot
yieldcurve,willprovidethecorrectdiscountratestopriceaparticularrisky
bond.
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Example
Afour-yearcorporatebondwitha7%couponhasaZ-spreadof200bps.
Assumeaflatyieldcurvewithaninterestrateforallmaturitiesof5%andannual
compounding.Thebondwillmostlikelysell:
A.closetopar.
B.atapremiumtopar.
C.atadiscounttopar.
26-386
Example
Answer:A
The200bpsZ-spreadcanbeaddedtothe5%ratesfromtheyieldcurveto
pricethebond.Theresulting7%discountratewillbethesameforallofthe
bond’scash-flows,sincetheyieldcurveisflat.A7%couponbondyielding
7
%willbepricedatpar.
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Example
TheZ-spreadofBondAis1.05%andtheZ-spreadofBondBis1.53%.Allelse
equal,whichstatementbestdescribestherelationshipbetweenthetwobonds?
A.BondBissaferandwillsellatalowerprice.
B.BondBisriskierandwillsellatalowerprice.
C.BondAisriskierandwillsellatahigherprice.
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Example
Answer:B
ThehigherZ-spreadforBondBimpliesitisriskierthanBondA.Thehigher
discountratewillmakethepriceofBondBlowerthanBondA.
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Example
Whichtermstructuremodelcanbecalibratedtocloselyfitanobservedyield
curve?
A.TheHo–LeeModel
B.TheVasicekModel
C.TheCox–Ingersoll–RossModel
30-386
Example
Answer:A
TheHo–Leemodelisarbitrage-freeandcanbecalibratedtocloselymatch
theobservedtermstructure.
31-386
Case:JaneNguyen
JaneNguyenisaseniorbondtraderandChristineAlexanderisajuniorbond
traderforaninvestmentbank.Nguyenisresponsibleforherowntrading
activitiesandalsoforprovidingassignmentstoAlexanderthatwilldevelopher
skillsandcreateprofitabletradeideas.Exhibit1presentsthecurrentparand
spotrates.
Exhibit1.CurrentParandSpotRates
Maturity
ParRate
2.50%
2.99%
3.48%
3.95%
4.37%
SpotRate
Oneyear
Twoyears
Threeyears
Fouryears
Fiveyears
2.50%
3.00%
3.50%
4.00%
Note:Parandspotratesarebasedonannual-couponsovereignbonds.
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Case:JaneNguyen
NguyengivesAlexandertwoassignmentsthatinvolveresearchingvarious
questions:
Assignment1:Whatistheyieldtomaturityoftheoption-free,defaultrisk–
freebondpresentedinExhibit2?Assumethatthebondisheldtomaturity,
andusetheratesshowninExhibit1.
Exhibit2.SelectedDatafor$1,000ParBond
BondName
BondZ
Maturity(T)
Threeyears
Coupon
6.00%
Note:TermsaretodayforaT-yearloan.
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Case:JaneNguyen
Assignment2:Assumingthattheprojectedspotcurvetwoyearsfrom
todaywillbebelowthecurrentforwardcurve,isBondZfairlyvalued,
undervalued,orovervalued?
Aftercompletingherassignments,AlexanderasksaboutNguyen’scurrent
tradingactivities.Nguyenstatesthatshehasatwo-yearinvestmenthorizonand
willpurchaseBondZaspartofastrategytoridetheyieldcurve.Exhibit1shows
Nguyen’syieldcurveassumptionsimpliedbythespotrates.
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Case:JaneNguyen
BasedonExhibit1,thefive-yearspotrateisclosestto:
A.4.40%
B.4.45%
C.4.50%
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Case:JaneNguyen
Answer:B
Thefive-yearspotrateisdeterminedbyusingforwardsubstitutionand
usingtheknownvaluesoftheone-year,two-year,three-year,andfour-year
spotratesasfollows:
0
.0437
0.0437
1.0302
0.0437
1.0353
0.0437
1.0404
1+0.0437
1
=
+
+
+
+
1
.025
1+푟5
5
1
0
.0437
5
푟5=
−1=4.453%
.8394
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Case:JaneNguyen
BasedonExhibit1,themarketismostlikelyexpecting:
A.deflation.
B.inflation.
C.noriskpremiums.
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Case:JaneNguyen
Answer:B
Thespotratesimplyanupward-slopingyieldcurve,r(3)>r(2)>r(1).
Becausenominalyieldsincorporateapremiumforexpectedinflation,an
upward-slopingyieldcurveisgenerallyinterpretedasreflectingamarket
expectationofincreasing,oratleastlevel,futureinflation(associatedwith
relativelystrongeconomicgrowth).
38-386
Case:JaneNguyen
BasedonExhibit1,theforwardrateofaone-yearloanbeginninginthreeyears
isclosestto:
A.4.17%.
B.4.50%.
C.5.51%.
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Case:JaneNguyen
Answer:C
Aone-yearloanbeginninginthreeyears,orf(3,1),iscalculatedasfollows:
3
+1
3
1
1
+푟3+1
=1+푟3
1+푓3,1
1
4
.040=1.0351+푓3,1
3
1
4
1
.04
푓3,1=
−1=5.514%
1
.0353
40-386
Case:JaneNguyen
BasedonExhibit1,whichofthefollowingforwardratescanbecomputed?
A.Aone-yearloanbeginninginfiveyears
B.Athree-yearloanbeginninginthreeyears
C.Afour-yearloanbeginninginoneyear
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Case:JaneNguyen
Answer:C
Exhibit1providesfiveyearsofparrates,fromwhichthespotratesforr(1),
r(2),r(3),r(4),andr(5)canbederived.Thustheforwardratef(1,4)canbe
calculatedasfollows:
1
+푟5
+푟1
5
4
푓1,4=
−1
1
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Case:JaneNguyen
ForAssignment1,theyieldtomaturityforBondZisclosesttothe:
A.one-yearspotrate.
B.two-yearspotrate.
C.three-yearspotrate.
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Case:JaneNguyen
Answer:C
Theyieldtomaturity,y(3),ofBondZshouldbeaweightedaverageofthe
spotratesusedinthevaluationofthebond.Becausethebond’slargest
cashflowoccursinYear3,r(3)willhaveagreaterweightthanr(1)andr(2)
indeterminingy(3).
Usingthespotrates:
$
60
$60
$1,060
푃푟푖푐푒=
+
+
=$1,071.16
1
.0251
1.0302
1.0353
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Case:JaneNguyen
Usingtheyieldtomaturity:
60
+푦31
$
$60
$1,060
푃푟푖푐푒=
+
+
=$1,071.16
1
1+푦32
1+푦33
Usingacalculator,thecomputeresultisy(3)=3.46%,whichisclosestto
thethree-yearspotrateof3.50%.
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Case:JaneNguyen
ForAssignment2,AlexandershouldconcludethatBondZiscurrently:
A.undervalued.
B.fairlyvalued.
C.overvalued.
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Case:JaneNguyen
Answer:A
Alexanderprojectsthatthespotcurvetwoyearsfromtodaywillbebelow
thecurrentforwardcurve,whichimpliesthatherexpectedfuturespotrates
beyondtwoyearswillbelowerthanthequotedforwardrates.Alexander
wouldperceiveBondZtobeundervaluedinthesensethatthemarketis
effectivelydiscountingthebond’spaymentsatahigherratethanshewould
andthebond’smarketpriceisbelowherestimateofintrinsicvalue.
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Case:JaneNguyen
BychoosingtobuyBondZ,Nguyenismostlikelymakingwhichofthefollowing
assumptions?
A.BondZwillbeheldtomaturity.
B.Thethree-yearforwardcurveisabovethespotcurve.
C.Futurespotratesdonotaccuratelyreflectfutureinflation.
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Case:JaneNguyen
Answer:B
Nguyen’sstrategyistoridetheyieldcurve,whichisappropriatewhenthe
yieldcurveisupwardsloping.TheyieldcurveimpliedbyExhibit1isupward
sloping,whichimpliesthatthethree-yearforwardcurveisabovethecurrent
spotcurve.Whentheyieldcurveslopesupward,asabondapproaches
maturityor“rollsdowntheyieldcurve,”thebondisvaluedatsuccessively
loweryieldsandhigherprices.
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Case:LauraMathews
LauraMathewsrecentlyhiredRobertSmith,aninvestmentadviseratShireGate
Advisers,toassistherininvesting.Mathewsstatesthatherinvestmenttime
horizonisshort,approximatelytwoyearsorless.Smithgathersinformationon
spotratesforon-the-runannual-coupongovernmentsecuritiesandswap
spreads,aspresentedinExhibit1.ShireGateAdvisersrecentlypublisheda
reportforitsclientsstatingitsbeliefthat,basedontheweaknessinthefinancial
markets,interestrateswillremainstable,theyieldcurvewillnotchangeitslevel
orshapeforthenexttwoyears,andswapspreadswillalsoremainunchanged.
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Case:LauraMathews
Exhibit1.GovernmentSpotRatesandSwapSpreads
Maturity(years)
1
2
3
4
Government
spotrate
2.25%
2.70%
3.30%
4.05%
Swapspread
0.25%
0.30%
0.45%
0.70%
SmithdecidestoexaminethefollowingthreeinvestmentoptionsforMathews:
Investment1:Buyagovernmentsecuritythatwouldhaveanannualized
returnthatisnearlyriskfree.Smithisconsideringtwopossible
implementations:atwo-yearinvestmentoracombinationoftwoone-year
investments.
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Case:LauraMathews
Investment2:Buyafour-year,zero-couponcorporatebondandthensellit
aftertwoyears.Smithillustratesthereturnsfromthisstrategyusingthe
swaprateasaproxyforcorporateyields.
Investment3:Buyalower-quality,two-yearcorporatebondwithacoupon
rateof4.15%andaZ-spreadof65bps.
WhenSmithmeetswithMathewstopresentthesechoices,Mathewstellshim
thatsheissomewhatconfusedbythevariousspreadmeasures.Sheiscurious
toknowwhetherthereisonespreadmeasurethatcouldbeusedasagood
indicatoroftheriskandliquidityofmoneymarketsecuritiesduringtherecent
past.
52-386
Case:LauraMathews
InhispresentationofInvestment1,Smithcouldshowthatundertheno-
arbitrageprinciple,theforwardpriceofaone-yeargovernmentbondtobe
issuedinoneyearisclosestto:
A.0.9662.
B.0.9694.
C.0.9780.
53-386
Case:LauraMathews
Answer:B
Theforwardpricingmodelisbasedontheno-arbitrageprincipleandis
usedtocalculateabond’sforwardpricebasedonthespotyieldcurve.The
spotcurveisconstructedbyusingannualizedratesfromoption-freeand
defaultrisk–freezero-couponbonds.
Equation2:P(T*+T)=P(T*)F(T*,T);weneedtosolveforF(1,1).
P(1)=1/(1+0.0225)1
andP(2)=1/(1+0.0270)2,
F(1,1)=P(2)/P(1)=0.9481/0.9780=0.9694.
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Case:LauraMathews
InpresentingInvestment1,usingShireGateAdvisers’interestrateoutlook,
Smithcouldshowthatridingtheyieldcurveprovidesatotalreturnthatismost
likely:
A.lowerthanthereturnonamaturity-matchingstrategy.
B.equaltothereturnonamaturity-matchingstrategy.
C.higherthanthereturnonamaturity-matchingstrategy.
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Case:LauraMathews
Answer:C
Whenthespotcurveisupwardslopinganditslevelandshapeare
expectedtoremainconstantoveraninvestmenthorizon(ShireGate
Advisers’view),buyingbondswithamaturitylongerthantheinvestment
horizon(i.e.,ridingtheyieldcurve)willprovideatotalreturngreaterthan
thereturnonamaturity-matchingstrategy.
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Case:LauraMathews
InpresentingInvestment2,Smithshouldshowatotalreturnclosestto:
A.4.31%.
B.5.42%.
C.6.53%.
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Case:LauraMathews
Answer:C
Theswapspreadisacommonwaytoindicatecreditspreadsinamarket.
Thefour-yearswaprate(fixedlegofaninterestrateswap)canbeusedas
anindicationofthefour-yearcorporateyield.Ridingtheyieldcurveby
purchasingafour-yearzero-couponbondwithayieldof4.75%{i.e.,4.05%
+
0.70%,[P4=100/(1+0.0475)4=83.058]}andthensellingitwhenit
becomesatwo-yearzero-couponbondwithayieldof3.00%{i.e.,2.70%+
0
6
.30%,[P2=100/(1+0.0300)2=94.260]}producesanannualreturnof
.53%:(94.260/83.058)0.5–1.0=0.0653.
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Case:LauraMathews
ThebondinInvestment3ismostlikelytradingatapriceof:
A.100.97.
B.101.54.
C.104.09.
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Case:LauraMathews
Answer:B
TheZ-spreadistheconstantbasispointspreadthatisaddedtothe
default-freespotcurvetopriceariskybond.AZ-spreadof65bpsfora
particularbondwouldimplyaddingafixedspreadof65bpstomaturities
alongthespotcurvetocorrectlypricethebond.Therefore,forthetwo-
yearbond,r(1)=2.90%(i.e.,2.25%+0.65%),r(2)=3.35%(i.e.,2.70%+
0
.65%),andthepriceofthebondwithanannualcouponof4.15%isas
follows:
P=4.15/(1+0.029)1
+4.15/(1+0.0335)2+100/(1+0.0335)2,
P=101.54.
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Case:LauraMathews
ThemostappropriateresponsetoMathewsquestionregardingaspread
measureisthe:
A.Z-spread.
B.Treasury–Eurodollar(TED)spread.
C.Libor–OIS(overnightindexedswap)spread.
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Case:LauraMathews
Answer:C
TheLibor–OISspreadisconsideredanindicatoroftheriskandliquidityof
moneymarketsecurities.Thisspreadmeasuresthedifferencebetween
LiborandtheOISrate.
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Case:RowanMadison
RowanMadisonisajunioranalystatCardinalCapital.SageWinter,asenior
portfoliomanagerandMadison’ssupervisor,meetswithMadisontodiscuss
interestratesandreviewtwobondpositionsinthefirm’sfixed-incomeportfolio.
WinterbeginsthemeetingbyaskingMadisontostateherviewsontheterm
structureofinterestrates.Madisonresponds:
“Yieldsareareflectionofexpectedspotratesandriskpremiums.Investors
demandriskpremiumsforholdinglong-termbonds,andtheseriskpremiums
increasewithmaturity.”
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Case:RowanMadison
WinternextasksMadisontodescribefeaturesofequilibriumandarbitrage-free
termstructuremodels.Madisonrespondsbymakingthefollowingstatements:
Statement1:“Equilibriumtermstructuremodelsarefactormodelsthatusethe
observedmarketpricesofareferencesetoffinancialinstruments,assumedto
becorrectlypriced,tomodelthemarketyieldcurve.”
Statement2:“Incontrast,arbitrage-freetermstructuremodelsseektodescribe
thedynamicsofthetermstructurebyusingfundamentaleconomicvariables
thatareassumedtoaffectinterestrates.”
WinterasksMadisonaboutherpreferencesconcerningtermstructuremodels.
Madisonstates:
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Case:RowanMadison
“Ipreferarbitrage-freemodels.Eventhoughequilibriummodelsrequirefewer
parameterstobeestimatedrelativetoarbitrage-freemodels,arbitrage-free
modelsallowfortime-varyingparameters.Ingeneral,thisallowanceleadsto
arbitrage-freemodelsbeingabletomodelthemarketyieldcurvemore
preciselythanequilibriummodels.”
WintertellsMadisonthat,basedonrecentchangesinspreads,sheisconcerned
aboutaperceivedincreaseincounterpartyriskintheeconomyanditseffecton
theportfolio.MadisonasksWinter:
“Whichspreadmeasureshouldweusetoassesschangesincounterpartyriskin
theeconomy?”
Winterisalsoworriedabouttheeffectofyieldvolatilityontheportfolio.She
asksMadisontoidentifytheeconomicfactorsthataffectshort-termandlong-
termratevolatility.Madisonresponds:
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Case:RowanMadison
“Short-termratevolatilityismostlylinkedtouncertaintyregardingmonetary
policy,whereaslong-termratevolatilityismostlylinkedtouncertaintyregarding
therealeconomyandinflation.”
Finally,WinterasksMadisontoanalyzetheinterestrateriskportfoliopositions
ina5-yearanda20-yearbond.Winterrequeststhattheanalysisbebasedon
level,slope,andcurvatureastermstructurefactors.Madisonpresentsher
analysisinExhibit1.
Exhibit1.Three-FactorModelofTermStructure
TimetoMaturity(years)
Factor
5
20
Level
Steepness
Curvature
–0.4352%
–0.0515%
0.3963%
–0.5128%
–0.3015%
0.5227%
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Case:RowanMadison
WinterasksMadisontoperformtwoanalyses:
Analysis1:Calculatetheexpectedchangeinyieldonthe20-yearbond
resultingfromatwostandarddeviationincreaseinthesteepnessfactor.
Analysis2:Calculatetheexpectedchangeinyieldonthefive-yearbond
resultingfromaonestandarddeviationdecreaseinthelevelfactoranda
onestandarddeviationdecreaseinthecurvaturefactor.
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Case:RowanMadison
Madison’sviewsonthetermstructureofinterestratesaremostconsistentwith
the:
A.localexpectationstheory.
B.segmentedmarketstheory.
C.liquiditypreferencetheory.
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Case:RowanMadison
Answer:C
Liquiditypreferencetheoryassertsthatinvestorsdemandariskpremium,
intheformofaliquiditypremium,tocompensatethemfortheadded
interestraterisktheyfacewhenbuyinglong-maturitybonds.Thetheory
alsostatesthattheliquiditypremiumincreaseswithmaturity.
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Case:RowanMadison
WhichofMadison’sstatement(s)regardingequilibriumandarbitrage-freeterm
structuremodelsisincorrect?
A.Statement1only
B.Statement2only
C.BothStatement1andStatement2
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Case:RowanMadison
Answer:C
BothstatementsareincorrectbecauseMadisonincorrectlydescribesboth
typesofmodels.Equilibriumtermstructuremodelsarefactormodelsthat
seektodescribethedynamicsofthetermstructurebyusingfundamental
economicvariablesthatareassumedtoaffectinterestrates.Arbitrage-free
termstructuremodelsuseobservedmarketpricesofareferencesetof
financialinstruments,assumedtobecorrectlypriced,tomodelthemarket
yieldcurve.
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Case:RowanMadison
IsMadisoncorrectindescribingkeydifferencesinequilibriumandarbitrage-
freemodelsastheyrelatetothenumberofparametersandmodelaccuracy?
A.Yes
B.No,sheisincorrectaboutwhichtypeofmodelrequiresfewerparameter
estimates
C.No,sheisincorrectaboutwhichtypeofmodelismorepreciseatmodeling
marketyieldcurves
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Case:RowanMadison
Answer:A
ConsistentwithMadison’sstatement,equilibriumtermstructuremodels
requirefewerparameterstobeestimatedrelativetoarbitrage-freemodels,
andarbitrage-freemodelsallowfortime-varyingparameters.Consequently,
arbitrage-freemodelscanmodelthemarketyieldcurvemoreprecisely
thanequilibriummodels.
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Case:RowanMadison
ThemostappropriateresponsetoMadison’squestionregardingthespread
measureisthe:
A.Z-spread.
B.Treasury–Eurodollar(TED)spread.
C.Libor–OIS(overnightindexedswap)spread.
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Case:RowanMadison
Answer:B
TheTEDspread,calculatedasthedifferencebetweenLiborandtheyieldon
aT-billofmatchingmaturity,isanindicatorofperceivedcreditriskinthe
generaleconomy.Anincrease(decrease)intheTEDspreadsignalsthat
lendersbelievetheriskofdefaultoninterbankloansisincreasing
(decreasing).Therefore,theTEDspreadcanbethoughtofasameasureof
counterpartyrisk.
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Case:RowanMadison
IsMadison’sresponseregardingthefactorsthataffectshort-termandlong-
termratevolatilitycorrect?
Yes
No,sheisincorrectregardingfactorslinkedtolong-termratevolatility
No,sheisincorrectregardingfactorslinkedtoshort-termratevolatility
76-386
Case:RowanMadison
Answer:A
Madison’sresponseiscorrect;researchindicatesthatshort-termrate
volatilityismostlylinkedtouncertaintyregardingmonetarypolicy,whereas
long-termratevolatilityismostlylinkedtouncertaintyregardingthereal
economyandinflation.
77-386
Case:RowanMadison
BasedonExhibit1,theresultsofAnalysis1shouldshowtheyieldonthe20-
yearbonddecreasingby:
A.0.3015%.
B.0.6030%.
C.0.8946%.
78-386
Case:RowanMadison
Answer:B
BecausethefactorsinExhibit1havebeenstandardizedtohaveunit
standarddeviations,atwostandarddeviationincreaseinthesteepness
factorwillleadtotheyieldonthe20-yearbonddecreasingby0.6030%,
calculatedasfollows:
Changein20-yearbondyield=–0.3015%×2=–0.6030%.
79-386
Case:RowanMadison
BasedonExhibit1,theresultsofAnalysis2shouldshowtheyieldonthefive-
yearbond:
A.decreasingby0.8315%.
B.decreasingby0.0389%.
C.increasingby0.0389%.
80-386
Case:RowanMadison
Answer:C
BecausethefactorsinExhibit1havebeenstandardizedtohaveunit
standarddeviations,aonestandarddeviationdecreaseinboththelevel
factorandthecurvaturefactorwillleadtotheyieldonthefive-yearbond
increasingby0.0389%,calculatedasfollows:
Changeinfive-yearbondyield=0.4352%–0.3963%=0.0389%.
81-386
Case:LizTyo
LizTyoisafundmanagerforanactivelymanagedglobalfixed-incomefundthat
buysbondsissuedinCountriesA,B,andC.Sheandherassistantare
preparingthequarterlymarketsupdate.Tyobeginsthemeetingbydistributing
thedailyratessheet,whichincludesthecurrentgovernmentspotratesfor
CountriesA,B,andCasshowninExhibit1.
82-386
Case:LizTyo
Exhibit1Today’sGovernmentSpotRates
Maturity
Oneyear
CountryA
0.40%
0.70
CountryB
-0.22%
-0.20
CountryC
14.00%
12.40
Twoyears
Threeyears
Fouryears
Fiveyears
1.00
-0.12
11.80
1.30
-0.02
11.00
1.50
0.13
10.70
83-386
Case:LizTyo
Tyoasksherassistanthowthesespotrateswereobtained.Theassistantreplies,
“Spotratesaredeterminedthroughtheprocessofbootstrapping.Itentails
backwardsubstitutionusingparyieldstosolveforzero-couponratesoneby
one,inorderfromlatesttoearliestmaturities.”
Tyothenprovidesareviewofthefund'sperformanceduringthelastyearand
comments,“Thechoiceofanappropriatebenchmarkdependsonthecountry's
characteristics.Forexample,althoughCountriesAandBhavebothanactive
governmentbondmarketandaswapmarket,CountryC'sprivatesectorismuch
biggerthanitspublicsector,anditsgovernmentbondmarketlacksliquidity.”
84-386
Case:LizTyo
Tyofurtherpointsout,“Thefund'sresultsweremixed;returnsdidnotbenefit
fromtakingonadditionalrisk.Weareespeciallymonitoringtheriskinessofthe
corporatebondholdings.Forexample,ourlargestholdingsconsistofthree
four-yearcorporatebonds(Bonds1,2,and3)withidenticalmaturities,coupon
rates,andothercontractterms.ThesebondshaveZ-spreadsof0.55%,1.52%,
and1.76%,respectively:”
Tyocontinues,“Wealsolookatriskintermsoftheswapspread.Weconsidered
historicalthree-yearswapspreadsforCountryB,whichreflectthatmarket's
creditandliquidityrisks,atthreedifferentpointsintime.”Tyoprovidesthe
informationinExhibit2.
85-386
Case:LizTyo
Exhibit2SelectedHistoricalThree-YearRatesforCountryB
Period
GovernmentBondYield(%)Fixed-for-FloatingLiborSwap
(%)
1
6
1
Monthago
Monthago
2Monthago
-0.10
-0.08
-0.07
0.16
0.01
0.71
86-386
Case:LizTyo
Tyothensuggeststhatthefirmwasabletoaddreturnbyridingtheyieldcurve.
Thefundplanstocontinuetousethisstrategybutonlyinmarketswithan
attractiveyieldcurveforthisstrategy.
Shemovesontopresenthermarketviewsontherespectiveyieldcurvesfora
five-yearinvestmenthorizon.
CountryA:“Thegovernmentyieldcurvehaschangedlittleintermsofits
levelandshapeduringthelastfewyears,and1expectthistrendto
continue.Weassumethatfuturespotratesreflectthecurrentforward
curveforallmaturities.”
CountrγB:“Becauseofrecenteconomi
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