Reading 30 EOC Question 27

CFA Level III
#1

Hi all, Can somebody explain why the answer is A? I believe A is generic answer but since the bond used in immunization are not callable, why the answer is not C? Many thanks, S

#2

pg 38 – Reading 29 – the 3 types of risk are contingent claim risk, interest rate risk and cap risk. Choice C reads : No Contingnet Claim risk IS NOT a factor… which is incorrect.

#3

Cp, When the bond is not callable, then it should not have any contigent claim risk- so c should be correct. I do agree with your first point on types of risk. Am I missing something here? Thanks

#4

I see what you are saying here - report an erratum to CFAI - and let’s see what they say.

#5

This is a common question. http://www.analystforum.com/phorums/read.php?13,1147030,1147199#msg-1147199 Corp bonds, which I believe are used in this case, have contingent claim on company assets, so let’s say if the bonds’ value is 20MUSD, but the company assets are deteriorating and are now only worth 10M --> in case of bankruptcy, the bondholders can only claim back 10M --> the claim is contingent on the company’s assets.

#6

Solarpower, I think you are right in your reasoning. However, based on the reading in page 38 Reading 28, I believe what they are trying to say is that contingent claim risk is largest for large coupon paying callable bonds. Even if the bond is not callable, a large paying coupon bond will still a sizeable contingent claim risk due to the fact that when rates fall, the reinvestment risk is accentuated. I guess there is a strong parallel between reinvestment risk and contingent claim risk. At least thats how I see it…

#7

intelo Wrote: ------------------------------------------------------- > I guess there is a strong > parallel between reinvestment risk and contingent > claim risk. At least thats how I see it… Not sure there is any connection between reinvestment risk and contingent claim risk, or between contingent claim risk and falling rate.

#8

P 38 of the book under contingent claim risk: “…the loss of coupons is bad enough but now the principal must be reinvested at a lower rate…” that’s reinvestment risk…I am not saying they are the same but I believe there is a parallel since they are both exposed to the same risk factors.