 # Bonds, Bonds, Bonds

1- Which of the following statements regarding financing bond purchases with margin accounts is FALSE? A) Individuals are more likely than institutions to use margin accounts to finance bond purchases. B) In the U.S., margin accounts are regulated by the Federal Reserve. C) The required margin percentage changes daily. D) The loan in a margin transaction is collateralized by the purchased security. 2- How does the convexity of a bond influence the yield on the bond? All else the same, for a bond with high convexity investors will require: A) a higher yield. B) the same yield as for a low convexity bond. C) a higher or lower yield depending on the bond’s duration. D) a lower yield. 3- A 30-year, 12% bond that pays interest annually is discounted priced to yield 14%. However, interest payments will be invested at 12%. The realized compound yield on this bond must be: A) 12.0%. B) between 12.0% and 14.0%. C) 14.0%. D) >14.0%.

1. C 2. D © 3. B

B D C

A D B

B D B

looks like everyone got #2 right, KJH was the closest 1-C) The required margin percentage changes daily. The margin percentage is fixed by contract. The required margin dollars may vary from day to day due to fluctuations in the underlying collateral. 2-D) a lower yield. Convexity is to the advantage of the bond holder because a high-convexity bond’s price will decrease less when rates increase and will increase more when rates decrease than a low-convexity bond’s price. 3-B) between 12.0% and 14.0%. Since you are reinvesting the current income at 12%, you will have a return of at least 12%. And since the bond is priced to yield 14%, you will earn no more than 14%.

A, D B

I don’t understand high convexity part ? A very high convexity will be something like a circle (very volatile) and low convexity (say zero convexity) will be a straight line, relatively less volatile. So, how is it D ??

High convexity means high price…thus you have to expect low yield.

I think high convexity indicates that the bond will appreciate much more quickly. High convexity cannot be something like a circle, or something that bends back, because the price will always have to approach 0 as yields increase (assuming option-free) and approach a very high value as yields decrease.

supersharpshooter Wrote: ------------------------------------------------------- > I think high convexity indicates that the bond > will appreciate much more quickly. > > High convexity cannot be something like a circle, > or something that bends back, because the price > will always have to approach 0 as yields increase > (assuming option-free) and approach a very high > value as yields decrease. High convexity means the bond will appreciate faster than it depreciates for a given change in interest rates.

Bondholders like convexity because- as interest decreases your bond value increases at faster rate while as interest rate increases it decreases at slower rate. So will be happy with lower yield. just my 2c S

B) D) A)

Good stuff Saurya.

With circle I meant a portion of circle (finite radius). But it makes sense, when you think in terms of price appreciation. Thanks guys !

convexity the price increase more than it decreases for the same change in interest rate.The higher the convexity the less yield an investor would require.

Isn’t A also false in Q1? Individuals should be less likely right?

I don’t think institutions buy on margin.

2 is D

prometheus231 Wrote: ------------------------------------------------------- > convexity > the price increase more than it decreases for the > same change in interest rate.The higher the > convexity the less yield an investor would > require. in laymans talk, it means capital gains > capital losses boom!