Name__________________________

Note: 2 points for putting name on every page.

points. There are a few extra points available.

Test will be graded out of 75

1) (2 points)The type of Muni bond that is backed by an issuer's taxing power is:
A. General obligation bond
B. Revenue Bond
C. Insured Bond
D. Refunded bond
2) Define the Absolute Priority rule with respect to corporate Credit Analysis. (2
pts)

3) List the three Major Credit Rating agencies (3 pts)

5) What is meant by debt to EBITDA? (2 points)

6) What is meant by NOI in Commercial mortgage backed deals? (2 points)

7) What is a disadvantage of a company funding with commercial paper? What is

an advantage?
(2 points)

8) Foreign government bond issuers could have an issuance curve in their local
currency and one in us dollars. (T or F). (2 pt)

9) Describe two of the credit risk factors examined when investing in international
government bonds? (4 pts)

10) What is an additional risk of investing in a countries local debt curve versus
their dollar debt curve?
(2 pts)

12) What is meant by loan to value? (2 points)

13) What are three main risk factors examined in corporate bond analysis? (3
points)

14) Which bond likely has higher yield? 10 year BBB rated bond or 5 year single A
rated bond? Give 2 reasons to justify answer. (3 points)

15) Describe and draw an upward sloping yield curve? (2 points)

16) Describe and list 2 theories that attempt to explain yield curve shape. (4
points)

17) What are the two primary drivers of mortgage credit analysis?
Answer is Loan to Value and Debt to Income.
I accepted other answers on first test but this is the official nswer.

18) In the sequential pay Agency Collateralized Mortgage Obligation structure

below proceeds from defaulted loans go first to the A tranche (T or F) (2 points)

Tranc
he

Par Amt

Coupon
Rate %

Weighted
Average Life

194,500,
000
36,000,0
00
96,500,0
00
73,000,0
00

A
B
C
D

7.5

1.2 yrs

7.5

4 yrs

7.5

7 yrs

7.5

10 yrs

19) In the following Non Agency Asset Backed Security deal, which is a sequential
pay structure, with subordinate tranches providing support to senior tranches, a
default in an underlying loan will first be absorbed by which tranche? (2 point)
Tranche

A1

800,000,000

Tranche

A2

100,000,000

Tranche

A3

50,000,000

Tranche

A4

20,000,000

Tranche

A5

10,000,000

Tranche

10,000,000

Tranche

6,000,000

Tranche

2,000,000

Tranche

Equity

2,000,000

20) (3 points) The issuer looking to raise money through a securitization is referred
to as the
A)
B)
C)
D)

Seller or Originator
Buyer
Agency
Purchaser

21) In a non agency mortgage backed security deal, why is it necessary to have
credit enhancement? (4 points)

22) Why is the senior subordinated structure a form of credit enhancement? (3

points)

23) CMOs shift the cash flow from mortgages so as to shift the prepayment risk
across various classes of bondholders (T or F) (2 points)
24) What type of property is security for a residential mortgage loan? (4 points)

25) How are Fico scores used in classifying loans? (4 points)

26) What is downgrade risk? (3 points)

27) (2 pts) Is it appropriate to use one yield to discount all cash flows in a financial
asset? (Yes or No)

28) How are forward rates related to spot rates? (2 points)

29) What is the equivalent taxable yield for an investor facing a 40% marginal tax
rate, and who can purchase a tax exempt municipal bond with a yield of 7.2%? (4
points)

Name: _________________________________________________(put on all pages)__

Note: Please reference the following formulas and notes for assistance in completing the exam.
Bond Equivalent Yield: A Bond Equivalent Yield (BEY) is the yield to maturity on a basis that ignores
compounding. If one says Bond Equivalent Basis they mean a basis for stating an annual yield that
annualizes a semiannual yield by doubling it. So, if you have a 4% Bond Equivalent Yield, it implies a
2% Semiannual Yield. Example: Bond Equivalent Interest Rate of 6% = 3% Semiannually. For a
Semiannual pay bond, doubling the periodic interest rate or discount rate (y) gives the yield to maturity,
which understates the effective annual yield. The yield to maturity computed on the basis of this market
convention is called the Bond Equivalent Yield.
Discount Rate formula for portion of bond prices that comes from coupons:

P = C

1
1

1 r

Discount Rate formula for portion of bond price that comes from maturity:

1+ r n

Sources of Return:
1) The interest-on-interest component can represent a substantial portion of a bonds potential
return. The coupon interest plus interest on interest can be found by using the following equation:

1 r n 1
C

2) The total dollar amount of coupon interest is found by multiplying the semiannual coupon interest
by the number of periods: total coupon interest = nC
3) The interest-on-interest component is then the difference between the coupon interest plus interest
on interest and the total dollar coupon interest, as expressed by the formula:

1 r n 1
nC

C
Interest on interest =

Effective Annual Yield:

Effective Annual Yield = (1 + periodic interest rate)m 1

Example 1: The effective annual yield of a 4% Bond Equivalent Yield is (1+.02) 2 1 = 4.04%.

Example 2: A bond with a 6% Yield to Maturity (YTM), has a Bond Equivalent Yield of 6%. A
semiannual periodic interest rate of 3% and an effective annual yield of (1+.03) 2 1 = 6.09%

Approximate Duration Formula:

P P
2 P0 y
Approximate Duration =
Annualized Return on a Bond:

total future dollars

purchase price of bonds

1/ h

Total Future Dollars includes return of principal, coupon interest, and interest on interest.

Formula relating to modified duration:

dP
P

= (modified duration)(0.01) = (modified duration)(%).

Discounting Equation for Zero Coupon Bond:

1 r n

where M is the maturity value. Thus, the price of a zero-coupon bond is simply the present value
of the maturity value.
Yield to maturity for a zero-coupon bond because we can use:

 M
y=
P

1/ n

1
.

1) Define Term to Maturity. (3 points)

2) Define Coupon. (3 points)

3) List and define two sectors of the Bond market. (4 points)

4) Brian and Don are reviewing two treasury securities.

Bond

Price

(4 points)

Modified Duration

90

50

Which Bond has higher DOLLAR PRICE volatility? Provide reasons for
your answer.

Which has more PERCENTAGE PRICE volatility? Provide Reasons for

your answer.

5) Bonds below are both callable bonds from the same issuer. (2
points)

Rate Change

Bond A
Bond B

-50 bpts

+ 50 bpts

+1%

-4%

+7%

-7%

One has coupon of 5% and the other has coupon for 8%.
Assuming YTM for both bonds are the same at 6% and maturity
is the same, which bond has the higher coupon and why?

6) If two bonds have the same duration, then the percentage

change in price of the two bonds is the same for any given
change in rates. Do you agree or disagree with the above
statement? Provide your rationale. (2 points)

7) Calculate the components of Present value that come from the

discounted final maturity payment and from the discounted coupon
payments for a 4 year, 1,000 Par, semiannual pay, 5% coupon bond,
priced at a 7% YTM. Please show the aggregate as well as how the
two components add to the total present value.
(4 points)

8)

(4 points total)

Calculate the Total Dollar Return including reinvestment income for a

1,000 par, 3% coupon, semiannual pay, 3 year bond. Assume coupon
payments can be reinvested at an annual (Bond Equivalent Yield
Rate) rate of 2 percent. Remember, a Bond Equivalent Yield of 2%
annually implies 1% Semiannually. Assume Bond is purchased at
Par. (1 point)

How much of total return comes from coupon (1 point) and how
much is from interest on
interest? (1 point).

If the bond were purchased at a bond price of 95 instead of a bond

price of 100, and the bond was held to maturity, how many
additional dollars should be included in the total return calculation?
(1 point)

9) (2 points)
Assume each bond below is offered at the same yield to maturity.
Which of following bonds has greatest dependence on Reinvestment
Income? (1point)

Bond Maturity

Coupon

25 Years

0%

15 years

4%

15 years

5%

Which bond is least dependent? (1 point)

10) A two year bond pays $5 in coupons semiannually (10% annual

coupon rate). It has a $100 par value. It has a yield to maturity is
9%. What is the price of the bond? (3 points) Show steps for
partial credit.

11) A pension fund manager invests $12 million in a five year debt
obligation that he
purchases at par. (3 points)
A. What does he pay for the bond?

B. Suppose the bond pays a 6.75% coupon paid semi-annually. What

is the total future value of this investment assuming he can
reinvest at a 6.75% Bond Equivalent Rate? Remember, the
semiannual rate for a 6.75% Bond Equivalent rate is 6.75%/2=
3.375%.

12)

Consider the following two Treasury securities: (3 points)

Bond
A
B

Price
$100
$ 70

Modified duration (years)

6
9

Which bond will have the greater dollar price volatility for a 25basis-point change in interest rates? Which will have the greater
percentage price volatility? Show work.

13)
With Respect to the following chart, explain the concept of
convexity. (3 points)

14) (2 points total) Using Table Below: Why does the 9% 5 year
bond have less volatile of a price move than the 6% 5 year bond
when rates fall from 9% to 8%? (1 point)
Why does the 0% 25 year bond have more price volatility when
rates move from 9 to 8% than the 0% 5 year bond? (1 point)

15) Please explain the concept of duration and how it is used to

measure the volatility of a bond or a portfolio? (2 points)

16) Assume a bond has a modified duration of 8. Yields fall by 100

basis points. The convexity adjustment applied to this 100 basis
point move is 1.2%. What is the percentage change in the price
of the bond after yields fall by 100 basis points? Please

contemplate both the effects of duration and convexity when

arriving at your answer. (2 points)

17) Using duration and convexity measures together gives a better

approximation of the actual price change for a large movement in
the required yield. (True or False) (1 point)

18)

With Reference to Modified Duration. (1 point)

Which of the following are true:

Macaulay duration
1 y
I)

modified duration =
dP 1
dy P
= modified duration.

II)

III)

A)
B)
C)
D)
E)

dP
P

= (modified duration)(0.01) = (modified duration)(%).

I only
II only
II and III only
I and III only
I, II, and III

19) Based upon chart below, which bond has greater convexity? (2
points)

20) Bond T has a modified duration of 10 yrs. Interest rates

change by 78 basis points. What is the approximate percentage
change in Bond T. For purposes of this question, disregard any
potential convexity adjustment. However, explain why our
estimate from modified duration will not exactly predict the price
change of the bond? (2 points)

21) List and define 4 of the risks related to investing in bonds. (4

points)

22)

What are the three sources of a bonds return?

(3 points)

23) If credit quality and required yield remain the same, under
what circumstances could the price of a bond still change as time
passes? Is this the case if a bond is priced at par? (2 points)

24) For a given term to maturity and initial yield, the price
volatility of a bond is greater, the lower the coupon rate. (True or
False) (1 point)

25) For a given coupon rate and initial yield, the longer the term to
maturity, the lower the price volatility. (True or False) (1 point)

26)

A debt obligation offers the following payments: (4 points)

Years from Now

Cash Flow to Investor
$3,000
$3,000
$5,500
$4,000

1
2
3
4

Suppose that the price of this debt obligation is $7,804. What is the
yield or internal rate of return offered by this debt obligation?
Show equation you would use to solve or show the calculator key strokes you
used. This will assist in attaining partial credit.

27) Solving for Y in the following equation reveals which bond

yield measure? (1 point)

CF 1 + CF 2 + CF 3 + . . .+ CFN
1
2
3
N
1+ y 1+ y 1+ y
1+ y
P=
A)
B)
C)
D)

Yield to Maturity
Current Yield
Duration
Convexity

28) The Yield to Maturity of a Bond is also known as the Bonds

Internal Rate of Return. (True or False) (1 point)

29) The Following Equation relates to which descriptive metric for

a bond? (1 point)

1C

1 y

2C

1 y

+ . . .+
P

A)
B)
C)
D)

Duration
Convexity
Yield to Maturity
Current Yield

nC

1 y

nM

1 y

30)

Consider the following Semiannual pay bond: (5 points)

Coupon rate = 11%
Maturity = 18 years
Par value = $1,000
First par call in 13 years
Only put date in five years and putable
at par value

Suppose that the market price for this bond $1,169.

(a)Show that the yield to maturity for this bond is 9.077%.

(b) Show that the yield to first par call is 8.793%.

(C) Show that the yield to put is 6.942%.

31)

Define Yield To Worst. (1 point)

32) Approximate the duration of a bond initially priced at 100

whose price will rise by 1% when interest rates fall 40 basis
points and whose price will fall by .9% when rates rise by 40 basis
points. (2 points)

33) Why do bonds with greater reinvestment risk generally have

less price volatility than bonds with less reinvestment risk? (2
points)

34) When prevailing yields in the market place (effectively the

rates we can reinvest at) differ from the YTM that existed when
we purchased a fixed income security, should we expect the price
of our fixed income instrument to change in price? (True or False)
(1 point)

35) Please consider the following two questions together. (2

points)
A) Assuming same maturity of two bonds from same issuer. When
the interest rate environment changes: more of the total return
change in a high coupon bond, compared to a low coupon bond,
will come from the change in reinvestment income because the
higher coupon bond has more interim coupon income that can be
reinvested at the current reinvestment rates? (True or False) (1
point)
Hint: For above question, remember total return is composed of Coupon
payments, reinvestment income, and bond price change.

B) Does your answer in part A) imply greater or lower price volatility

for the high coupon bond compared to the low coupon bond? (1
point)

36) Please list the cash flows for bond W and Bond X. Both bonds
are semiannual pay bonds (8 points). Show them Period by
Period.

Bond
W
X

Coupon Rate (%)

7
8

Number of Years to Maturity

2
3

Price
$884.20
$948.90

37) Suppose that you are reviewing a price sheet for bonds and
see the following prices (per $100 par value) reported. You
observe what seem to be several errors. Without calculating the
price of each bond, indicate which bonds seem to be reported
incorrectly, and explain why. (6 points)

Bond
U
V
W
X
Y
Z

Price
90
96
110
105
107
100

Coupon Rate (%)

6
9
8
0
7
6

Required Yield (%)

9
8
6
5
9
6

38)
Suppose that an investor with a five-year investment horizon
is considering purchasing a seven-year semiannual pay 8%
coupon bond selling at par. The investor expects that he can
reinvest the coupon payments at an annual bond equivalent
interest rate of 7.4% and that at the end of the investment
horizon two-year bonds will be selling to offer a yield to maturity
of 9.2%. What is the expected total return for this bond? (8
points)

39)

Calculate the duration of the following Portfolio. (2 points)

Bond
W
X
Y
Z

Market Value
$13 million
$27 million
$60 million
$40 million

Duration (years)
2
7
8
14

40) What is effective annual interest rate of a bond with an 8%

Yield to maturity? Remember, 8% Yield to maturity implies a 4%
Semiannual rate. (2 points)