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2024-05-23Effective duration is equal to:

the negative of the percentage change in price divided by the change in the interest rates in basis points. Effective duration has become increasingly popular because of the limitations of Macaulay and modified durations.

the percentage change in price divided by the change in the interest rates in basis points divided by 100. The use of effective duration has declined considerably because of the widespread application of the more useful Macaulay and modified durations.

the negative of the percentage change in price divided by the change in the interest rates in basis points divided by 100. Effective duration has become increasingly popular because of the limitations of Macaulay and modified durations.

the percentage change in price divided by the change in the interest rates in basis points. The use of effective duration has declined considerably because of the widespread application of the more useful Macaulay and modified durations.

Macaulay and modified durations cannot be used for large yield changes, for assets with embedded options, or for other assets that are affected by variables other than interest rates. For this reason, many market practitioners use effective duration, which is a direct measure of interest rate sensitivity.

2024-05-22

Anna Bell, a portfolio manager for a large U.S. bank, is considering the purchase of a new issue of debt securities. She has noticed that the issue has an indenture provision requiring the issuer to retire a certain portion of the bonds on an annual basis.

This requirement for the issuer to retire part of the issue prior to the stated maturity date is designed to reduce the risk to the bondholders and is known as a ________.

put provision

sinking-fund provision

callable provision

bullet bond

Many bond issues have indentures that require a certain amount of the issue to be retired each year. This requirement is known as a sinking-fund provision or requirement. The purpose of a sinking fund requirement is the reduction of credit risk to the bondholder.

Callable provisions allow the issuer to call the bond before its issue date if desirable (if interest rates decline) and putable provisions allow the investor to sell the bond back to the issuer if desirable (if interest rates increase).

A bullet maturity bond allows the issuer to repay the principal by the stated maturity date and does not require that principal payments be made prior to that date.

2024-05-21

If a Treasury bill has 115 days between settlement and maturity, and its yield on a discount basis is 3.91%, what is the price of this T-bill?

.9855

.9875

.9609

.9825

1.0391

The price is calculated as:

1 − 0.0391(115/360) = .9875

2024-05-20

A debt security that does not pay periodic interest payments and is sold at a discount to face value is known as which of the following?

floating-rate bond

zero-coupon bond

deferred coupon bond

step-up note

A zero-coupon bond is sold at a discount (many times a significant discount) to face value. While these types of bonds do not make periodic interest payments, the investor is able to redeem the bonds for the full face value at maturity.

Step-up notes have coupon rates that increase over time. A bond with a floating-rate has a coupon rate that is reset periodically according to some reference rate. A bullet bond typifies most U.S. bonds where the principal is paid in a lump sum by the maturity date.

2024-05-19

Calculate the accrued interest of a $1,000, 8% coupon bond.

Assume that the bond's interest payments are made semi-annually and that it has been rated as an investment grade security by the major rating services.

You are currently 117 days into a 182-day coupon period.

$80.00

$19.89

$14.28

$35.23

$31.14

$40.00

$25.71

Since you are currently 117 days into a 182-day coupon period, 64.3% of the interest payment has accrued up until this point. The semi-annual interest payment is $40. Thus .643 × 40 = $25.71.

Accrued interest is the coupon amount earned by the seller between the last coupon date and the settlement date. The buyer must compensate the seller for this amount. In this case, the bond rating was irrelevant to the calculation.