Qbank - fixed income

CFA Level III
#1

[Adjusted, delete non-important part] - Bond A has the longer modified duration at 9.50 with a yield of 9.12%.

  • Bond B has a modified duration of 7.30 and a yield of 7.80%. If PM buys Bond B, what is the required basis point change in the spread (in terms of the required yield on Bond B) to offset Bond A’s yield advantage? A) 13.89474 bp due to a decline in the yield. B) 18.08219 bp due to a decline in the yield. C) 14.72190 bp due to an increase in the yield.
#2

This is one that I vaguely remember getting wrong. I would do this:

[(9.12%-7.8%)/7.3 = 18.08bps

I’d use 7.3 in the denominator as you’re working from the perspective of owning bond B. However I think Schweser go with:

[(9.12%-7.8%)/9.5 = 13.89bps

They use 9.5 as its the higher duration of the two.

#3

Well the question clearly ask what is the yield change that is required to remove A yield advantage so A is correct. I mean does not matter what he bought, what matter is the question.

#4

Dam, seeing questions like this make me lose all confidence… I completely forgot how to do this.

I’d guess B, for the same reason as Swiftly. I disagree with Glue85 because a decrease in yield of bond A would increase the price and create further separation in total return.

#5

Frank, can we get an answer to this soon please? I didn’t plan on reviewing fixed income until next week, but I’m very curious.

#6

Sure! Your answer is correct. This time needs to choose the shorter duration given from bond B perspective.

Answer: B

Bond A has a yield advantage of 132 basis points relative to Bond B. An increase in Bond B’s credit rating will increase its price and lower its yield. Since we are looking at this in terms of Bond B: (1.32/-7.30) x 100 = -18.08219bp, the breakeven change in yield is -18.08219bp, or a decline in the yield on Bond B resulting in the widening of the spread between A and B by this amount. The increase in price for Bond B will result in capital gains for Bond B, which will offset A’s original yield advantage. Note that the CFA curriculum specifies using the bond with the greater duration which in this case would be bond A although as we have demonstrated in this question the bond with the shorter duration can also be used. Thus, if you are not told which bond to use to perform the calculation you should use the one with the greater duration.

#7

Thank you. Great review material.

#8

Guys

is q bank good for FI/Derivatives?

I am struggling in these chapters

#9

It’s useful to scan/pick up the basic concept.

But it’s not enough to deal with exam. Better combine it with past exm/mock, EOC, and BB.

#10

Good question…I thought we always use long duration for break-even analysis…

#11

In short: always use the greater duration even if in this case it would not be the correct answer.

#12

^ agreed.