Concept Questions 10

Prof. Itamar Drechsler

1. Question Which of the following factors unambiguously cause an increase
in the duration of a coupon paying bond?
(a) an increase in maturity, an increase in coupon rate and an increase in the YTM.
(b) an increase in maturity, a decrease in coupon rate and an increase in the YTM.
(c) an increase in maturity, an increase in coupon rate and a decrease in the YTM.
(d) an increase in maturity, a decrease in coupon rate and a decrease in the YTM.
2. What is the duration D on the following annual pay bond: Face value =
100, maturity, 3 years, coupon rate = 10%, yield to maturity 10%? (you
do not need a calculator to solve this question)
(a) D=3 years (duration = maturity)
(b) P= 110, D = (10/(1.1 P )) 1 + (10/(1.12 P )) + (110/(1.13 P ))
(c) P= 100, D = (10/(1.1 P )) 1 + (10/(1.12 P )) 2 + (110/(1.13 P )) 3
(d) P= 100, D = (10/(1.1 P )) 1 + (10/(1.1 P )) 2 + (110/(1.1 P )) 3
3. If the current interest rate is 5% and your semi-annual coupon paying bond
has a duration of 5.33 years, how much will the price of the bond change if
the interest rate increases by 1 basis point?
(a) change in price = -5.33 * .0001
(b) change in price = -5.33 * .01
(c) change in price = -(5.33/1.05) * .0001
(d) change in price = -(5.33/1.05) * .01
4. If you are a bank with liabilities of duration 4 years, how will you choose
the composition of your assets to eliminate the interest rate risk that you
would be exposed to if you had a duration mismatch on your balance sheet?
Assume there exist only 3 year and 25 year assets.
(a) I would purchase a portfolio consisting for 50% of 3 year for 50% of 25 year bonds
with a total value equal to the value of my liabilities. This will equal the duration
of assets and liabilities.
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(b) I would purchase a portfolio consisting for 90% of 3 year and for 10% of 25 year
bonds with a total value equal to the value of my liabilities. This will equal the
duration of assets and liabilities.
(c) I would purchase a portfolio consisting for 95% of 3 year and for 5% of 25 year
bonds with a total value equal to the value of my liabilities. This will equal the
duration of assets and liabilities.
(d) I would purchase a portfolio consisting for 10% of 3 year and for 90% of 25 year
bonds with a total value equal to the value of my liabilities. This will equal the
duration of assets and liabilities.
5. What is true about the seller of a put option (short a put)?
(a) This person has the right to sell the underlying at the strike price
(b) This person has the obligation to sell the underlying at the strike price
(c) This person has the right to buy the underlying at the strike price
(d) This person has the obligation to buy the underlying at the strike price
6. Why does an investor buy a call option?
(a) Because he/she thinks the stock price could go down.
(b) Because he/she thinks the stock price could go down and he/she wants to limit
the downside risk.
(c) Because he/she thinks the stock price will go up and he/she wants to limit the
downside risk.
(d) Because he/she thinks the stock price could go up.
7. If you buy a European put with strike price $100 and expiration in 1 year,
which costs $10, and the price on expiration is $70, what is the (annual)
rate of return on your investment?
(a) (100-70-10/70) = 28.57%
(b) (100-70-10)/10 = 200%
(c) 70/10 = 700%
(d) (70-10)/10 = 600%
8. If you own 1 unit of stock and you are afraid of downside risk, you should
buy a put option (protective put). Suppose you buy a put with strike $80
at a price of $10. What will be the value of your portfolio, net of the cost
of the option, if the price ends up at 95?
(a) $85
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(b) $95
(c) $100
(d) $110