36 RELATE TO INTEGRATED ANALYTICS. JANE HIGGINS, CFA, AND...

Questions 31-36 relate to Integrated Analytics.

Jane Higgins, CFA, and Tanya Tyler, CFA, are portfolio managers for Integrated Analytics (IA), a

U.S.-based investment analysis firm. The firm specializes in active bond management and

currency management for both individual and institutional portfolios.

Higgins and Tyler are considering investing in U.S. and U.K. bonds. They consider a variety of

potential yield curve and other strategies. They collect the data in Table 1 on liquid U.S. and U.K.

government bonds.

Table 1: Yield on Government Bonds

Duration United States United Kingdom

0.9 0.50% 1.00%

1.9 0.80% 1.70%

3.0 1.00% 2.00%

4.1 1.10% 2.10%

4.9 1.20% 2.20%

5.8 1.25% 2.25%

Specifically they are interested in:

1. "Riding the curve" over the next year.

2. Buying convexity with the use of long or short positions in call and/or put options on U.K.

3. A carry trade between U.S. and U.K. three-year duration bonds.

Higgins and Tyler are also considering the purchase of a bond issued by a Norwegian petroleum

firm, Bergen Petroleum. Their expectations are quantified in Table 2.

Table 2:

Return on Bergen Petroleum Bond in Norweigan NOK 7.00%

Risk-free rate in Norway 2.80%

Expected change in the NOK relative to the U.S. dollar -0.40%

Risk-free rate in United States 0.50%

After making the investment in the Bergen bonds, they reconsider their market expectations and

determine they will hedge the NOK currency risk with a one-year forward contract. However, they

find that market has become inactive and transaction costs are high. There is a more active

forward market for the Swedish currency (SEK) and they construct a cross hedge by selling the

SEK forward to buy the USD.

Finally, Higgins and Tyler consider the purchase of a BB-rated U.S. corporate bond. The bond

has a duration of 3.5 and a yield of 3.70%. While they agree it is an improving credit story and

that spread will narrow, they do not agree on how to best measure the credit spread.

 Higgins says we can use Table 1 to compute the G-spread of the U.S. bond as being 3.64%.

 Tyler says the I-spread is superior because it is based on swap fixed rates and these have

less credit risk.

 Tyler also acknowledges that G-spread has an advantage because it is the return we can

expect to earn if we hedge interest rate risk.

...

Based on the data presented, it is most likely correct to say a "riding the curve" strategy:

A) assumes the level of the yield curve will change.

B) would be more profitable in the United Kingdom than in the United States.

C) cannot work in the U.S. yield curve environment.

Question #32 of 60

Buying convexity will most likely:

A) involve increasing the portfolio's yield.

B) require selling calls but not puts.

C) require buying both calls and puts.

Question #33 of 60

Based on the data presented, it is most correct to say the carry trade:

A) involves borrowing in the United States and investing in the United Kingdom.

B) does best when interest rate parity correctly predicts the change in value of currencies.

C) would perform better if U.S. rates decrease and U.K. interest rates increase.

Question #34 of 60

Based on the data in Table 2, should the Bergen Petroleum bond be hedged against currency

risk and what is the hedged return?

A) No, the hedged return is 4.70%.

B) No, the hedged return is 6.60%.

C) Yes, the hedged return is 6.60%.

Question #35 of 60

In order for the cross hedge of selling the SEK forward to work, the correlation of:

A) SEK and NOK must be high, approaching +1.

B) SEK and USD must be high, approaching +1.

C) Both the SEK and NOK must be highly correlated to the USD, approaching +1.

Question #36 of 60

Regarding their statements concerning the spread for the BB-rated U.S. corporate bond,

the most correct statement is:

A) Higgins' comment on G-spread.

B) Tyler's comment on I-spread.

C) Tyler's comment on G-spread.

Question #37 of 60