"Fixed Income":Long-term bond investors
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Questions 1:
A long-term bond investor with an investment horizon of 8 years invests in option-free, fixed-rate bonds with a Macaulay duration of 10.5. The investor most likely currently has a:
A 、positive duration gap and is currently exposed to the risk of lower interest rates.
B 、positive duration gap and is currently exposed to the risk of higher interest rates.
C、 negative duration gap and is currently exposed to the risk of higher interest rates.
Questions 2:
If an issuer is required to retire a specified portion of the bond’s principal each year, the bond most likely:
A、 is callable.
B 、is a step-up note
C、 has a sinking fund provision.
B is correct. The duration gap is the bond’s Macaulay duration minus the investment horizon, which is positive in this case. A positive duration gap implies that the investor is currently exposed to the risk of higher interest rates.
A is incorrect because while the duration gap is positive the investor is currently exposed to the risk of higher, not lower, interest rates.
C is incorrect because the duration gap is positive, not negative, implying that the investor is currently exposed to the risk of higher interest rates.
C is correct. A sinking fund provision requires retirement of a portion of the bond’s principal every year, rather than retirement of the entire issue at maturity.
A is incorrect because a bond that is currently callable may be retired by the issuer, but the issuer is not required to do so.
B is incorrect because a step-up note has a coupon rate that increases over time according to a predetermined schedule.
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