) 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