Fixed Income Securities

ANSWERS TO QUESTIONS FOR CHAPTER 1 (Questions are in bold print followed by answers. ) 2. What is meant by a mortgage- patronageed pledge? A mortgage-backed security is a security backed by peerless or more mortgage loans. Like a fond regard that is turn toable, a mortgage-backed security allows the investor to grant the borrower an option. 4. What is the cash track down of a 10-year adhesion that pays verifier participation semiyearlyly, has a coupon rate of 7%, and has a equality cheer of $100,000? The principal or par value of a draw together is the amount that the issuer agrees to repay the lodgeholder at the due date date.The coupon rate cipher by the principal of the oblige provides the dollar amount of the coupon (or yearly amount of the interest payment). A 10-year alignment with a 7% annual coupon rate and a principal of $100,000 pass on pay biannual interest of (0. 07/2)($100,000) = $3,500 for 10(2) = 20 periods. Thus, the cash proceed is $3,500. In a ddition to this nightly cash, the issuer of the stick by is obligated to pay back the principal of $100,000 at the measure the last $3,500 is paid. 6. Give three reasons why the due date of a bring together is important.There are three reasons why the term to matureness of a bond is important. First, the term to maturity indicates the time period over which the holder of the bond good deal expect to receive the coupon payments and the number of years in the beginning the principal ordain be paid in full. Second, the term to maturity is important because the be subscribe to on a bond depends on it. The condition of the yield curve determines how the term to maturity affects the yield. Third, the price of a bond will fluctuate over its life as yields in the trade change.The volatility of a bonds price is dependent on its maturity. More specifically, with all other factors constant, the longer the maturity of a bond, the greater the price volatility resulting from a change in trade yields. 8. rationalize whether or not an investor loafer determine today what the cash flow of a floating-rate bond will be. Floating-rate bonds are issues where the coupon rate resets sporadically based on a general formula equal to the bring up rate plus the quoted margin. The reference rate is some index discomfit to change.The exact change is unknown and uncertain. Thus, an investor cannot determine today what the cash flow of a floating-rate bond will be in the future. 10. What is an inverse-floating-rate bond? plot of ground the coupon on floating-rate bonds reliant on an interest rate bench mark typically rises as the benchmark rises and falls as the benchmark falls, in that respect are issues whose coupon interest rate moves in the opposite vigilance from the change in interest rates. Such issues are called inverse floaters. 12. (a) What is meant by an amortizing security?The principal quittance of a bond issue can be for either the total principal to be rep aid at maturity or for the principal to be repaid over the life of the bond. In the latter(prenominal) case, there is a schedule of principal repayments. This schedule is called an amortization schedule. Loans that chip in this amortizing feature are automobile loans and home mortgage loans. There are securities that are created from loans that have an amortization schedule. These securities will then have a schedule of periodic principal repayments.Such securities are referred to as amortizing securities. (b) Why is the maturity of an amortizing security not a useful measure? For amortizing securities, investors do not talk in terms of a bonds maturity. This is because the declared maturity of such(prenominal) securities only identifies when the final principal payment will be made. The repayment of the principal is being made over time. 14. What does the call feature in a bond entitle the issuer to do? The nearly common type of option embedded in a bond is a call feature.This p roviso grants the issuer the right to retire the debt, fully or partially, before the scheduled maturity date. 16. What does the put feature in a bond entitle the bondholder to do? An issue with a put provision included in the indenture grants the bondholder the right to sell the issue back to the issuer at par value on designated dates. The advantage to the bondholder is related to the hatchway that if interest rates rise after the issue date (thereby minify a bonds price) the bondholder can force the issuer to redeem the bond at par value. 8. How do market participants suppose the omission peril of a bond issue? It is common to define credit risk as the risk that the issuer of a bond will fail to recompense the terms of the obligation with respect to the timely payment of interest and repayment of the amount borrowed. This form of credit risk is called default risk. Market participants gauge the default risk of an issue by looking at the default rating or credit rating assi gned to a bond issue by one of the three rating companiesStandard & distressings, Moodys, and Fitch. 0. Does an investor who purchases a zero-coupon bond face reinvestment risk? The calculation of the yield of a bond assumes that the cash flows received are reinvested. The additional income from such reinvestment, sometimes called interest-on-interest, depends on the prevailing interest-rate levels at the time of reinvestment, as head as on the reinvestment strategy. Variability in the reinvestment rate of a assumption strategy because of changes in market interest rates is called reinvestment risk.This risk is that the interest rate at which interim cash flows can be reinvested will fall. Reinvestment risk is greater for longer holding periods, as well as for bonds with large, early cash flows, such as high-coupon bonds. For zero-coupon bonds, interest is reinvested at the resembling rate as the coupon rate. This eliminates any risk associated with the possibility that coupon p ayments will be reinvested at a lower rate. However, if rates go up, then the zero coupon bond will fall in value because its locked-in rate is below the higher market rate. 22.What is meant by sucker a position to market? Marking a position to market actor that periodically the market value of a portfolio must be determined. Thus, it can refer to the practice of reporting the value of assets on a market rather than book value basis. Marking to market can also refer to settling or reconciling changes in the value of futures contracts on a daily basis. 24. What is risk risk? There have been new and innovative structures introduced into the bond market. Money managers do not continuously understand the risk/return characteristics of these securities.Risk risk is defined as not knowing what the risk of a security is because those involved in issue and buying securities are not aware of what can happen. There are two ways to mitigate or eliminate risk risk. The kickoff approach is to keep up with the literature on the state-of-the-art methodologies for analyzing securities. The arcminute approach is to avoid securities that are not clearly understood. 26. What is a price-risk-transferring transformation? A price-risk-transferring innovation is an innovation that provides market participants with more efficient means for dealing with price or exchange rate risk.