Fixed-Income Securities Analysis Flashcards

An investor is analyzing a 5-year corporate bond with a 4% coupon, currently trading at $960. The bond's face value is $1,000. Which of the following statements about its yield to maturity (YTM) is most accurate?

Answer: The YTM is greater than the coupon rate.

When a bond trades at a discount (price is less than face value), its yield to maturity will be greater than its coupon rate. This is because the investor not only receives the coupon payments but also realizes a capital gain when the bond matures at its par value of $1,000. The calculation for YTM accounts for both the interest payments and this price appreciation.

Which of the following fixed-income securities is backed by specific physical assets, offering the highest level of security to the bondholder in the event of issuer default?

Answer: Mortgage Bond

A mortgage bond is a type of secured debt instrument that is backed by the pledge of specific assets, typically real estate. In contrast, a debenture is unsecured, relying on the general creditworthiness of the issuer. Commercial paper is also unsecured short-term debt. Canada Savings Bonds are backed by the Government of Canada but are not secured by specific physical assets.

A portfolio manager expects interest rates to fall significantly over the next year. To maximize potential capital gains in her bond portfolio, she should focus on bonds with:

Answer: High duration and high convexity

Duration measures a bond's price sensitivity to changes in interest rates; a higher duration means a larger price increase when rates fall. Convexity measures the curvature of the price-yield relationship. Positive convexity means that for a given change in yields, the price increase will be larger than the price decrease. Therefore, to maximize gains from falling rates, a manager would want bonds with both high duration and high convexity.

An issuer would be most likely to exercise the call feature on a callable bond under which of the following economic conditions?

Answer: A period of declining interest rates

Issuers call bonds to refinance their debt at a lower cost. This becomes advantageous when market interest rates have fallen below the coupon rate of the outstanding callable bond. By calling the old, higher-coupon bond, they can issue new bonds at the current, lower rates, thus saving on interest expense.

Which of the following is a key difference between a Government of Canada Treasury Bill (T-bill) and corporate Commercial Paper?

Answer: Commercial paper carries credit risk, whereas T-bills are considered virtually risk-free.

T-bills are backed by the full faith and credit of the Government of Canada, making them one of the safest investments available. Commercial paper is unsecured short-term debt issued by corporations, and therefore carries the risk that the corporation may default on its obligation. Both are sold at a discount and mature at face value without paying periodic coupons.

An investor purchases a bond that gives them the right to sell it back to the issuer at a predetermined price and date before maturity. This feature is known as a:

Answer: Retractable feature

A retractable feature, also known as a put provision, grants the bondholder the right to sell the bond back to the issuer at a specified price on a specific date before the final maturity date. This is in contrast to a call provision, which gives the issuer the right to redeem the bond early.