FixedIncome_TutorialQuestions_1

Teaching Week 9 - Fixed Income Tutorial 2

Fabozzi Ch. 4 & Ch. 5

1.Given the information in the first and third columns, complete the table:

2. A floating rate issue has the following coupon formula:

1-year Treasury rate + 30 basis points with a cap of 7% and a floor of 4.5%

The coupon rate is reset every year. Suppose that at the reset date the 1-year Treasure rate is as shown below. Compute the coupon rate for the next year:

3.Explain whether you agree or disagree with each of the following statements:

a.“The foreign bond market sector of the Japanese bond market consists of bonds of

Japanese entities that are issued outside of Japan.”

b.“Because b onds issued by central governments are backed by the full faith and

credit of the issuing country, these bonds are not rated.”

4.Suppose a portfolio manager purchases $1 million of par value of a Treasury Inflation

Protected Security (TIPS). The real rate (determined at the auction) is 3.2%.

a.Assume that at the end of the first 6 months the CPI-U is 3.6% (annual rate).

Compute the (i) inflation adjustment to principal at the end of the first six months,

(ii) the inflation-adjusted principal at the end of the first six months, and (iii) the

coupon payment made to the investor at the end of the first six months.

5.Mortgage backed securities, and asset backed securities, have some unique characteristics

to be considered by investors.

a.What is a prepayment?

b.What do the monthly cash flows of a mortgage-backed security consist of?

c.What is a curtailment?

6.What is the difference between liquidation and reorganization? What is the principle of

absolute priority?

7.Why is the default rate alone not an adequate measure of the potential performance of

corporate bonds?