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Study Session 15: Fixed Income: Basic Concepts

Wiley - CMO Prepayment Risk Question

Hi,

Consider the following statements:

  • Statement 1: A pool of mortgage loans serves as collateral for collateralized mortgage obligations (CMOs).
  • Statement 2: In a sequential-pay CMO, the tranche with the longest average life entails the least extension risk.

Which of the following is most likely?

The correct answer is both statements are incorrect. However, the explanation states sequential-pay CMOs have the greatest protection from contraction risk and has the most extension risk.

Effective yield

Isn’t it more useful (and correct) in practice to calculate the effective yield of each bond?

I see in some cases we simply see what the 6-month rate is and then we simply double that to get to the annualized YTM. However, that doesn’t seem to be “correct” to me. The effective rate seems more correct as it uses compounding to get the yearly rate from the 6-month rate.

Do you agree?

Wrong answer in the book Convexity

At page 274 of the 5th book:

In answer number 3 the delta yield should be positive 0,01 instead of negative and the convexity-adjusted percentage price drop resulting from a 100bp increase in YTM is estimated to be 8,1555%.

the answer says -0,81549 when it should be -0,81555 as stated in the beginning of the answer.

Reading 45 ■ Introduction to Asset- Backed Securities

Could someone help me to understand the below as per my understanding the lender should get $175,000? Because the underlying property is the house or is it not clear from the question?

Q: Fran Martin obtains a non- recourse mortgage loan for $500,000. One year later, when the outstanding balance of the mortgage is $490,000, Martin cannot make his mortgage payments and defaults on the loan. The lender forecloses on the loan and sells the house for $315,000. What amount is the lender entitled to claim from Martin?

Reading 44 ■ Introduction to Fixed- Income Valuation

My concern is why for 7 years, the answer is not considering N=12 instead of 6 because it’s a semi-annual bond? Could anyone please help with the explanation?

Q: Assume a city issues a $5 million bond to build a new arena. The bond pays 8% semiannual interest and will mature in 10 years. Current interest rates are 9%. What is the present value of this bond and what will the bond’s value be in seven years from today?

Explanation

Present Value:

Currency Option Bond

They give bondholders the right to choose the currency in which they want to receive interest payments and principal repayments.
Bondholders can select one of two currencies for each payment.

So You have 4 options of receiving the payments or just 2?

Lets suppose the options are Dollar/Euro

Like I can

opt to receive principal in Dollar and the coupons in Dollar

opt to receive principal in Dollar and the coupons in Euro

opt to receive principal in Euro and the coupons in Euro

Meaning of "net of the current portion" of long-term debt

I really just want to confirm this, but if you were to see the phrase “long-term debt, net of the current portion,” that would mean only long-term debt on the balance sheet, not including the current portion right? So if there is $1 million in long-term debt and $200,000 in the current portion of long-term debt, this company would have $1.2 million in interest-bearing debt, and its long-term debt, net of the current portion, would be $1 million. 

Thanks.

Fixed Income Test Questions

Here are some questions, could someone confirm if the answers are correct ?

1. Which of the following bond categories has typically lower yield to maturity than short-term
treasury bonds?
(a) Long-term treasury bonds. I would say b)
(b) Short-term municipal bonds.
(c) Short-term corporate bonds.
(d) Callable corporate bonds.
(e) None of the above.