) GIVEN VERTEX'S INTEREST RATE VOLATILITY AND YIELD CURVE FORECASTS IN STATEMENT 4, COMPARED WITH BULLET STRUCTURES, CALLABLE STRUCTURES AND PUTABLE STRUCTURES, RESPECTIVELY, WILL MOST LIKELY

5.) Given Vertex's interest rate volatility and yield curve forecasts in Statement 4, compared

with bullet structures, callable structures and putable structures, respectively, will most

likely:

A.

Callable Structures: Underperform and Putable Structure: Outperform

B.

Callable Structures: Outperform and Putable Structures: Outperform

C.

Callable Structures: Outperform and Putable Structure: Underperform

Answer = B

Spong's fourth statement indicates that Vertex expects a 25 bp rise in short-term rates

and a 75 bp increase in long-term rates—that is, the yield curve is expected to steepen.

In this environment callables and putables will outperform bullet structures. As rates

rise, given low implied interest rate volatility, the probability of a call diminishes as does

the value of the call option. Consequently, callables will outperform bullets. As rates rise

the put option becomes more valuable, furthermore the put allows the investor to put

the option back at par, thus avoiding losses. For these reasons, the value of the putable

structure can be expected to increase. In contrast, the bullet structure will decline in

value. Thus, putables also outperform bullets.

“Relative Value Methodologies for Global Credit Bond Portfolio Management,” by Jack

Malvey

Sections 7, 8