Final Exam Solution Essay

1308 WordsMar 18, 20126 Pages
BUFN 762 Fixed Income Securities Final Exam Solution 1. Briefly explain why many corporations prefer to issue callable long-term corporate bonds rather than noncallable long-term bonds. There are three main reasons why a corporation may be interested in calling a bond. * Interest rated have fallen, so they can refinance at a lower rate. * Credit quality has improved, so they can refinance at a lower rate. * Assets have been sold, so money is available to pay off debt. 2. Briefly explain the idea behind an Immunized Bond Portfolio. With an Immunized Portfolio, the duration and convexity of the assets is set to match the duration and convexity of the liabilities. The PV of the assets is set greater than the…show more content…
Briefly explain why the Inverse Floating Rate Bond has a much longer effective duration than the underlying fixed cash flow. If rates increase, then both bonds lose value because they are discounted at a higher rate. But the inverse Floater will also lose value because the coupon payments decrease. The opposite holds when rates decrease. Therefore, the price impact is greater for Inverse Floaters than for Straight Bonds. Note that there is another way to think of this. A portfolio made up of an inverse floater and a floater must have the same duration as a fixed cash flow bond. Since the floater has a very short duration, the inverse floater must have a longer duration than the average. 9. Briefly explain why Salomon Brothers was able to make a profit while they were squeezing the Two-Year Treasury. Salomon Brothers operated in four markets. 1. They paid a little more than the fair price for the bonds in the Primary Market, but that allowed them to control the issue. In order to do this they illegally bought more than they were allowed to buy. 2. They paid a fair price in the When-Issued market. Doing so gave them even greater control over the issue. 3. They charged a higher than fair price in the Secondary Market. They sold the issue slowly in order to maintain the premium. 4. The loaned the security in the Repo Market at special rates. Others had to
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