Quiz # 3

A Six year 8% (annual) coupon bond is selling at a par. The duration of the bond is


(a) 5.23;
(b) 3.88;
(c) 5.85;
(d) 4.98;




The convexity of the above bond is :


(a) 12;
(b) 28;
(c) 2.35;
(d) Cannot be determined from the above information.




Negative Convexity is a property whereby:


(a) The duration of the assets fall in rallying markets and increase in            falling markets;
(b) The duration of the assets rise in rallying markets and decrease in falling            markets;
(c) Duration more and less remains constant in both rallying and falling markets;
(d) None of the above.




Convexity becomes important for a bond or a fixed income instrument when


(a) For a very large moves in the market rates;
(b) For a very highly leveraged positions;
(c) Only when option-like features are involved in an asset;
(d) All the above;




Which of the following instruments display Negative convexity:


(a) Mortgage backed securities;
(b) Callable corporate bonds;
(c) Bond options;
(d) All the above;




A large multinational corporation is seeking to finance a new plant & machinery project with either fixed income funding. The plant & machinery has a useful life of 10 years.The company's past experience has shown that the net income from the business generated by the plant & machinery of the kind built varies with general level of interest rates.In particular the company has found that the net income move roughly in step with the 1-year year rates. The company can achieve the best asset/liability match by:


(a) Financing the plant & machinery by means of a 10-year non-callable fixed            rate bond issue;
(b) Financing the plant & machinery with a 10-year floating rate note (FRN)            tied to 3-month LIBOR;
(c) Financing the plant & machinery with an issue 10-year non-callable fixed            rate bond and then swapping the bond with a floating 1-year LIBOR;
(d) Financing the plant & machinery with a 5-year floating rate note (FRN) tied            to 1-year LIBOR;




EQL is an equipment leasing company whose assets are leases which generate mostly fixed cash flows; and its liabilities are mostly fixed rate bond issues and commercial paper swapped to fixed. The dollar duration of the assets of the company are $2 million and the dollar duration of the liabilities is $2.5 million. In order to match its assets/liabilities risk the company needs to:


(a) Purchase some (long) assets;
(b) Enter into an interest rate swap in which it receives fixed to add the             additional duration that it needs;
(c) Both of the above;
(d) Sell some assets;




HK Homes is a construction company with BBB rating and has recently issued a 10-year 8% coupon bond to finance a new project. Though the company initially believed that it was fully hedged it has now realized that the construction industry is subject to high volatility and has discovered that its operating results decline as the rates increase. The company can achieve a good hedge by:


(a) By entering into a swap in which it receives floating LIBOR and pays a fixed             rate of say, 7%
(b) By entering into a swap in which it receives a fixed rate payment of say, 7%             and it pays a floating LIBOR;
(c) By buying options on LIBOR;
(d) None of the above;




The dollar duration of zero in option terminology is equivalent to:


(a) Gamma neutral portfolio;
(b) Delta neutral portfolio;
(c) Delta-Gamma neutral portfolio;
(d) Vega neutral portfolio;




One of the earliest and most celebrated swap transactions that practically created the swaps market was:


(a) Between UBS and Coca Cola company in 1988;
(b) Between World Bank and IBM in 1981;
(c) Between Citibank and Walt Disney in 1982;
(d) None of the above;

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