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Risks Associated With Investing in Bonds - Class Examples

The document provides examples to illustrate different types of bond risks: 1) The third bond has the highest interest rate sensitivity due to its short maturity and callable feature. 2) The zero-coupon bond is more price sensitive to interest rate changes than the coupon bond due to its longer duration. 3) The zero-coupon bond has the smallest price volatility because it does not make coupon payments. 4) For a client concerned with low interest rate risk, the bond with the shortest maturity and intermediate coupon rate is the best choice.

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111 views10 pages

Risks Associated With Investing in Bonds - Class Examples

The document provides examples to illustrate different types of bond risks: 1) The third bond has the highest interest rate sensitivity due to its short maturity and callable feature. 2) The zero-coupon bond is more price sensitive to interest rate changes than the coupon bond due to its longer duration. 3) The zero-coupon bond has the smallest price volatility because it does not make coupon payments. 4) For a client concerned with low interest rate risk, the bond with the shortest maturity and intermediate coupon rate is the best choice.

Uploaded by

mohammed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Interest rate risk example 1

Which of the following bonds has


the highest interest rate sensitivity? A:
A)   ten year, option-free 6% coupon bond.
B)   ten year, option-free 4% coupon bond.
C)   five year, 5% coupon bond callable in one year.

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Interest rate risk example 2
.Which of the following two bonds is more price sensitive to changes in
interest rates?
1) A par value bond, X, with a 5-year-to-maturity and a 10% coupon
rate.
2) A zero-coupon bond, Y, with a 5-year-to-maturity and a 10% yield-to-
maturity. 

A. Bond X because of the higher yield to maturity.


B. Bond X because of the longer time to maturity.
C. Bond Y because of the longer duration.

2
Interest rate risk example 3
Holding other factors constant, which one of
the following bonds has the smallest price
volatility? 

A. 5-year, 0% coupon bond


B. 5-year, 12% coupon bond
C. 5 year, 14% coupon bond

3
Interest rate risk example 4
Tom Wilkens is a portfolio manager and has a retiree as a
client. The client would like to invest in bonds with low
interest rate risk. Which bond should Tom choose for his
client? The bond with a:
A)   20 year maturity and a yield to maturity of 5%.
*B)   10 year maturity and a yield to maturity of 8%.
C)   10 year maturity and a yield to maturity of 5%.
D)   20 year maturity and a yield to maturity of 8%.

4
Reinvestment risk example 1
Which of the following choices correctly places callable bonds, straight
coupon bonds, mortgage-backed securities, and zero-coupon bonds in
order from the type of security with the least reinvestment risk to the
one with the most reinvestment risk?
A) zero-coupon bonds, straight coupon bonds, callable bonds,
mortgage-backed securities.
B) zero-coupon bonds, mortgage-backed securities, straight coupon
bonds, callable bonds.
C) callable bonds, straight coupon bonds, zero-coupon bonds,
mortgage-backed securities.

5
Reinvestment risk example 2
Kyle Barnes, CFA, is meeting his friend, Lita Rombach, about
possible bond investments. Rombach is concerned about
reinvestment risk. Which of the following statements about
Rombach is TRUE? Rombach:
A) will prefer a higher coupon bond to a lower coupon
bond.
B) need only be concerned about reinvestment risk on
coupon payments.
C) will prefer a noncallable bond to a callable bond.

6
Reinvestment risk example 3
An investor holds a 20-year, semi-annual 8.00% coupon
Treasury bond issued at par. Market interest rates are
currently at 6.50%. The bond is noncallable. A coupon
payment is due this week. Which of the following choices
best represents the type of risk the investor faces?

A) Reinvestment risk.
B) Prepayment risk.
C) Credit risk.

7
Factors that cause credit spreads to
widen include:
A worsening credit cycle
A weak macroeconomic climate
A decline in financial markets
A lack of market makers (broker-dealers)
Insufficient demand for bond issuances
Credit downgrades
Falling liquidity

8
Liquidity Risk example
A Treasury bond is quoted as 99:11 asked and
99:09 bid. What is the bid-ask spread in dollars on a
$5,000 face value bond? 
A. $0.03
B. $0.63
C. $1.00
D. $3.13
E. $6.25
Bid-ask spread = 99:11 - 99:09 = 2/32 of 1 percent
of $5,000 = $3.13

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Event risk example
Kira Sigard, CFA and an attorney with an investment banking
firm, structures a client’s bond issue to include a “poison put.”
This is a provision that requires the issuer to redeem the bond at
par in the case of a corporate takeover, a merger, or anti-
takeover measure that would dissipate significant corporate
assets. An investor who purchases this bond is protected from
what type of risk?

A. Event Risk.
B. Liquidity Risk.
C. Call Risk.

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