2.01.2005

Finance for Dummies

Q&A: Explain the spread between the yield of a TIP strip...
...and a nominal Treasury strip with the same maturity. A : Since a nominal strip is more liquid than a TIP strip, it should provide a lower yield. But the nominal strip presents the possibility ...

Q&A: Consider an investor with a marginal tax rate of 30%...
...If municipal securities yield 6 and a comparable corporate yields 7.5 , which is the better investment? A : For an investment of $100, the municipal security will provide a yield of $6 ...

Q&A: Bootstrap the spot rate for...
...the 4th coupon payment period, given the following market data for $100 par Treasury bonds Period Years Annual YTM (BEY)( ) Price Spot Rate (BEY) ( ) 1 .5 3.0 3.0 2 1.0 3.3 3.3 3 1.5 3 ...

Q&A: Alan Greenspan, the chairman of the Federal Reserve...
...made the following remark concerning the advantages of introducing TIPS: By routinely monitoring the markets for the indexed and unindexed debt instruments, the Federal Reserve could extract ...

Q&A: In the Wall Street Journal, you note that the GNMA yields...
...are about 100 basis points higher than Treasuries with comparable maturities. On this basis can we conclude that GNMAs are better investments than Treasuries? A : GNMAs have prepayment ...

Q&A: If the inflation risk is high, how will the central bank...
...attempt to contain that risk? A : The central bank will try to tighten the availability of credit, by increasing the target fed funds rate (thus making credit dearer). This will force firms ...

Q&A: What is the duration/convexity of...
...a 12 , 12-year, option-free bond selling at $125? A : Duration (V- V+) / (2 V0 yield change) yield: with Excel Rate function, Nper 24, PV 125, PMT 12/2, FV 100, which leads to rate 4.31 ...

Q&A: Under what types of market structure would...
...it be possible to have two separate but simultaneous transactions where bond X was traded at unit prices of $105 and $95 respectively? A : A broker gets involve when buyers and sellers ...

Q&A: Under what circumstance should an American call...
...be exercised early? A : American call options are never exercised early unless the underlying makes cash payments. Stocks pay dividends, bonds pay interest, foreign currencies pay interest ...

Q&A: List at least 2 reasons why Yield-To-Maturity...
...of a bond may not be realized. A Reinvestment risk: future interest rates may be less than the YTM at the time the bond is purchased, leading to less reinvestment income (ie. the interest ...

Q&A: Is there an arbitrage opportunity...
...given the following market data for $1000 par bonds? Year .5 1.0 1.5 2.0 Market Price $900 $900 $900 $900 Coupon 10 10 10 10 Spot Rate 15 16 15 14 A : One should buy the 2 year Treasury ...

Q&A: If an investor holds a 14.00%, 17.50 year bond bought at $950.00 to maturity...
...what is the reinvestment income, assuming rates remain constant? A Required Rate of Return current yield/2 Annual interest payment / Bond price / 2 14/950 / 2 0.7 FV of total Interest Payments ...

Q&A: What is the reinvestment income if...
...an investor holds a 14.00 , 17.50 year bond bought at $950.00 to maturity, with the market interest rate at 15.00 ? A FV of total cash flows PV (1+r)^N $950.00 (1+15/2/100)^(17.50 2) $11940 ...

Q&A: What's the 6-month forward rate...
... 2 years from now given the following spot rates? Period Years to Maturity Spot Rate 1 .5 4.250 2 1 4.750 3 1.5 5.050 4 2.0 7.000 5 2.5 8.750 6 3.0 9.250 A : 4th period forward rate can ...

Q&A: What is the total cash flows received...
... if an investor purchases a 3-year, 8 coupon bond that has a 10 YTM, assuming the semi-annual bond is held to maturity? A : Total cash flow FV of total Interest Payments Capital gain ...

Q&A: Which is the Z-spread for...
...a 3.5-year, 9.60 , $100 par non-Treasury bond selling for 110.2950: 100 basis points, 143bp, or 165bp? Period Spot Rate 1 0.03 2 0.033 3 0.035053 4 0.039164 5 0.044376 6 0.04752 7 0.049622 ...

Q&A: What's the yield-to-first-call of...
...a 8-year, 6 , $100 par bond selling for $104.50, if the first call date is in 3 years with a call price of $102? A : With Excel Rate function, Nper 6, PV 104.5, PMT 6/2 3.5, FV 102, rate ...

Q&A: What's the reinvestment income of...
...the 2nd coupon payment of a 5-year, 8 $100 par bond when the reinvestment rate is 10 ? A : coupon FV par FV 100 8 /2 5.9-4 $1.9 With Excel FV function, Nper 8, Rate 10/2 ,PV 100 8 /2 ...

Q&A: How is a regular redemption price different from...
...a special redemption price? A : A regular redemption price is the normal call price for a typical callable bond (after the first call date). It is usually above par until the first par ...

Q&A: If an investor needs to borrow funds for bonds purchase...
...what are some of the more common sources he can turn to? A Margin Buying: The funds are provided by the broker, and the broker gets the money from a bank using the same underlying bond ...

Q&A: Why is it important to recognize the options embedded...
...in a bond? A : A bond may have more than one embedded option, and these options have a direct effect on the value of a bond, as well as the performance of a bond measured by the rate of ...

Q&A: If an investor believes that yield curve will flatten...
...what could he do to benefit from it? A : He could short sell 2-year treasury bond and purchase 10-year treasury bond, for instance. Flatten yields mean long term yields decrease relative ...

Q&A: What are some of the more common coupon rate structures?
A Zero-coupon bonds: pay the face amount at a future maturity date, without any interim interest payments. ie. a zero-coupon bond with $1,000 par is quoted at 80. The interest is $200. A type ...

Q&A: What's the difference between a non-callable bond...
... and a non-refundable bond? A : Non-refundable prevents redemption only from certain sources, namely the proceeds of other debt issues sold at a lower cost of money (ie. when interest rates ...

Q&A: List some duties of the trustee appointed...
...when bonds are issued? A Make sure terms of the indenture are obeyed Manage the sinking fund Monitor the protective covenants for the bondholders Represent the bondholders in default Bonus ...

Q&A: What's the trader referring to when he says...
... "6s of 1/1/2010 trading at 98"? A : A bond that has a 6 coupon rate, matures at 1/1/2010 and is selling for 98 of its par value. Bonus Points A fixed income security is an obligation of ...

Q&A: What are the coupon payments for a $50,000 par value...
...8 coupon rate, monthly-pay, mortgage-backed security? A : $50,000 8 / 12 333.33 With monthly coupon payments, the annual coupon rate is divided by 12 to determine the monthly coupon rate ...

Q&A: What are some of the things generally included in a bond indenture?
A The basic terms of the bond. Details of the protective covenants. Sinking fund arrangements. Call provisions. Bonus Points A bond indenture is a written agreement between the issuer and ...

Q&A: List some of the assumptions fundamental analysis makes....
...in regard to the notion of efficient markets. A : At any time, there is a basic intrinsic value for the aggregate stock market, various industries, or individual securities. These values ...

Q&A: Give an example how portfolio managers can beat...
...a buy-and-hold strategy on a risk-adjusted basis. A : When the market fails to adjust prices rapidly to public information, porfolio managers can achieve superior investment performance ...

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