01.EXPLANATION(STUDY SESSION 14, LOS 47.H)QUESTION #20 OF 88 QUESTIO...

3.01.

Explanation

(Study Session 14, LOS 47.h)

Question #20 of 88

Question ID: 463836

In regard to the effect of a change in the size of the rate shock on the duration and convexity estimates, Karstein is:

ᅞ

A)

incorrect in her analysis of the effect on both bonds.

correct in her analysis of the effect on both bonds.

ᅞ

B)

ᅚ

C)

correct only in her analysis of the effect on the 4.75% 2010 bond.

Duration and convexity estimates for bonds without embedded options will not be significantly affected by changing the size of

the rate shock from 100 basis points to 50 basis points. However, for bonds with embedded options, the size of the rate shock

can have a significant effect on the estimates.

We know from Part 3 that the 2025, 5.85% bond exhibits significant negative convexity, which is consistent with a callable

bond. The 2010, 4.75% bond has positive convexity, even when yields are significantly below the coupon rate and the bond is

trading at a substantial premium. That suggests the 2010, 4.75% bond has no embedded options.

We would expect that changing the size of the rate shock would have a significant effect on the 2025, 5.85% callable bond, but

not on the 4.75% 2010 bond. Therefore, Karstein is correct in her analysis of the 4.75% bond, but not the 5.85% bond. (Study

Session 14, LOS 47.g)

Question #21 of 88

Question ID: 463837

The portfolio convexity adjustment, assuming a 100 basis point decrease in yield, is closest to:

ᅚ

A)

+1.77%.

−2.93%.

ᅞ

C)

−1.77%.

Question #22 of 88

Question ID: 463823

When is it best for an asset-backed security (ABS) to be valued using the zero-volatility spread approach?

For agency ABS.

To value ABS that have a prepayment option.

To value ABS that do not have a prepayment option.

With the zero-spread method, the value of an ABS is the present value of its cash flows discounted at the spot rates plus the zero-

volatility spread. The Z-spread technique does not incorporate prepayments. Thus, it should only be used for ABSs for which the borrower

either has no option to prepay, or is unlikely to.

Question #23 of 88

Question ID: 472712

Alnoor Hudda, CFA is valuing two floaters issued by Mateo Bank. Both floaters have a par value of $100, three year life and

pay based on annual LIBOR. Hudda has generated the following binomial tree for libor.