BUFN 762 Final Exam Solution (attached solution)

BUFN 762  Final Exam Solution (attached solution)

Final Exam Solution

Final Exam Solution

   1. Briefly explain why many corporations prefer to issue callable long-term corporate bonds rather than noncallable long-term bonds.

   2. Briefly explain the idea behind an Immunized Bond Portfolio.

   3. Explain why an Interest Only Strip (IO MBS) usually gains value when interest rates increase.

   4. Briefly explain what happens to the price of a straight bond (no options) when the yield increases – and why.

   5. Briefly describe how the Federal Reserve moves rates in the Federal Funds Market.

   6. Suppose that you want to hedge the interest rate risk of a Fixed Income Security that has negative convexity.   Suppose that you can create a perfect hedge with futures and options (paying a premium to buy the options).   As an alternative, you can use hedge with futures alone.   If you believe that the true volatility

 will be much lower than the implied volatility of the options, which alternative should you choose?   Why?

   7.   Briefly explain the idea behind splitting a companion CMO tranche into a floating rate class and an inverse rate floating rate class.

   8. Suppose that a fixed cash flow treasury bond is split into two bonds, a floater and an inverse floater.   Briefly explain why the Inverse Floating Rate Bond has a much longer effective duration than the underlying fixed cash flow.

   9. Briefly explain why Salomon Brothers was able to make a profit while they were squeezing the Two-Year Treasury.

   10. Briefly explain why straight Corporate Bonds have a higher yield than Treasury Bonds with the same coupon rate and maturity.

   11. Theoretical Spot Rates will be close to Zero Coupon Bond Yields.   Explain why there may be small differences in the real world.

   12. Assume the following (all rates are stated annually with semiannual compounding):

       a. Six Month Spot Rate is 2.5%

       b. Six Month Forward rate starting at month six is

 2.8%

       c. Six Month Forward rate starting at month 12 is 3.2%

 Then find the price of an 18 month Zero Coupon Bond (Treasury Strip).

   13. Name three features that you feel should be included in a Term Structure Model.

   14. Describe why some bonds are On Special in the Repo Market.

   15. State the most useful thing you learned in this course and why you think it is useful.