1. Given the yield curve for US Treasury zero-coupon bonds, which spread is most
ID: 2736306 • Letter: 1
Question
1. Given the yield curve for US Treasury zero-coupon bonds, which spread is most helpful in pricing a corporate bond? The:
A)Z-spread.
B)TED spread.
C)LIBOR-OIS spread.
2. An option-adjusted spread (OAS) on a callable bond is the Z-spread:
A)Over the benchmark spot curve.
B)Minus the standard swap rate in that currency of the same tenor.
C)Minus the value of the embedded call option expressed in basis points per year.
3.The risk that a bond’s creditworthiness declines is best described by:
A)Credit migration risk.
B)Market liquidity risk.
C)Spread-widening risk.
4.Which of the following sources of return is most likely exposed to interest rate risk for an investor of a fixed-rate bond who holds the bond until maturity?
A)Capital gain or loss.
B)Redemption of principal.
C)Reinvestment of coupon payments.
5.Which of the following statements related to secondary bond markets is most accurate?
A)Newly issued corporate bonds are issued in secondary bond markets.
B)Secondary bond markets are where bonds are traded between investors.
C)The major participants in secondary bond markets globally are retail investors.
Explanation / Answer
Answer:1 A)Z-spread.
Because A higher zspread implies a riskier bond. Most useful for pricing a corporate bond.
Answer:2 C)Minus the value of the embedded call option expressed in basis points per year.
The option value in basis points per year is subtracted from the Z-spread to calculate the option-adjusted spread (OAS). The Z-spread is the constant yield spread over the benchmark spot curve. The I-spread is the yield spread of a specific bond over the standard swap rate in that currency of the same tenor.
Answer:3 A)Credit migration risk.
Because Credit migration risk or downgrade risk refers to the risk that a bond issuer's creditworthiness may deteriorate or migrate lower. The result is that investors view the risk of default to be higher, causing the spread on the issuer's bonds to widen.
Answer: 4 C)Reinvestment of coupon payments.
Because Because the fixed-rate bond is held to maturity (a "buy-and-hold" investor), interest rate risk arises entirely from changes in coupon reinvestment rates. Higher interest rates increase income from reinvestment of coupon payments, and lower rates decrease income from coupon reinvestment. There will not be a capital gain or loss because the bond is held until maturity. The carrying value at the maturity date is par value, the same as the redemption amount. The redemption of principal does not expose the investor to interest rate risk. The risk to a bond's principal is credit risk.
Answer:5 B)Secondary bond markets are where bonds are traded between investors.
Secondary bond markets are where bonds are traded between investors. A is incorrect because newly issued bonds (whether from corporate issuers or other types of issuers) are issued in primary (not secondary) bond markets. C is incorrect because the major participants in secondary bond markets globally are large institutional investors and central banks (not retail investors).
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