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©2013 Pearson Education 1 OVERVIEW OF CONTENTS Chapter 1 introduces the text. Chapters 2–5 set forth the basic analytical framework necessary to understand the pricing of bonds and their investment characteristics. Chapter 6 introduces Treasury securities, Treasury derivative securities, and […]

©2013 Pearson Education 216 CHAPTER 10 RESIDENTIAL MORTGAGE LOANS CHAPTER SUMMARY Although the American dream may be to own a home, the major portion of the funds to purchase one must be borrowed. The market where these funds are borrowed […]

CHAPTER 11 AGENCY MORTGAGE PASS-THROUGH SECURITIES CHAPTER SUMMARY In this chapter and the two that follow, we discuss the different sectors in the residential mortgage-backed security (RMBS) market. In the current chapter, we will focus on what agency mortgage pass-through […]

WEIGHTED AVERAGE LOAN TERM 360 mo WEIGHTED AVERAGE REMAINING MATURITY 359 mo WEIGHTED AVERAGE LTV 73% WEIGHTED AVERAGE CREDIT SCORE 729 Answer the below questions. a. What does the “pass–through rate” of 5% for this security mean? It means that […]

CHAPTER 12 AGENCY COLLATERALIZED MORTGAGE OBLIGATIONS AND STRIPPED MORTGAGE-BACKED SECURITIES CHAPTER SUMMARY In this chapter we discuss two derivative mortgage-backed securities products: collateralized mortgage obligations and stripped mortgage-backed securities. In the agency mortgage-backed securities markets, these securities are referred to […]

The payment rules state (i) how to disburse periodic coupon interest to each tranche on the basis of the amount of principal outstanding at the beginning of the period, and (ii) how to disburse principal payments to tranches based on […]

©2013 Pearson Education 290 CHAPTER 13 NONAGENCY RESIDENTIAL MORTGAGE-BACKED SECURITIES CHAPTER SUMMARY In this chapter, we discuss the nonagency RMBS market, focusing on the structure of the securities created, particularly on credit enhancement. We will describe the different forms of […]

©2013 Pearson Education 310 CHAPTER 14 COMMERCIAL MORTGAGE LOANS AND COMMERCIAL MORTGAGED-BACKED SECURITIES CHAPTER SUMMARY The mortgage market consists of residential mortgages and commercial mortgages. Residential mortgage loans are for properties with one to four single-family units. Residential mortgage–backed securities […]

CHAPTER 15 ASSET-BACKED SECURITIES CHAPTER SUMMARY A security created by pooling loans other than residential primemortgage loans and commercial mortgage loans is referred to as an asset-backed security (ABS). The market classifies securities backed by subprime mortgage loans as mortgage-related […]

collateral must be used. This schedule, which is explained in the deal’s prospectus, is known as the cash flow waterfall, or simply the waterfall. At the top of the waterfall would be cash flows due to senior bondholders (interest and […]

©2013 Pearson Education 352 CHAPTER 16 INTEREST-RATE MODELS CHAPTER SUMMARY In implementing bond portfolio strategies there are two important activities that a manager will undertake. First, a manager will want to determine whether the bonds that are purchase and sale […]

CHAPTER 17 ANALYSIS OF BONDS WITH EMBEDDED OPTIONS CHAPTER SUMMARY In this chapter we look at how to analyze bonds with embedded options. Because the most common type of option embedded in a bond is a call option, our primary […]

12. If an on-the-run issue for an issuer is evaluated properly using a binomial model, how would the theoretical value compare to the actual market price? For an on-the-run issue that is option-free the theoretical value is identical to the […]

©2013 Pearson Education 397 CHAPTER 18 ANALYSIS OF RESIDENTIAL MORTGAGE-BACKED SECURITIES CHAPTER SUMMARY There are two approaches to the analysis of residential mortgage-backed securities including pass-throughs, collateralized mortgage obligations (CMOs), and stripped mortgage-backed securities. They are: (1) the static cash […]

©2013 Pearson Education 417 CHAPTER 19 ANALYSIS OF CONVERTIBLE BONDS CHAPTER SUMMARY This chapter focuses on convertible bonds. We explain methodologies for analyzing convertible bonds, beginning with a review of the basic provisions. CONVERTIBLE BOND PROVISIONS A convertible bond is […]

©2013 Pearson Education 14 CHAPTER 2 PRICING OF BONDS CHAPTER SUMMARY This chapter will focus on the time value of money and how to calculate the price of a bond. When pricing a bond it is necessary to estimate the […]

©2013 Pearson Education 437 CHAPTER 20 CORPORATE BOND CREDIT ANALYSIS CHAPTER SUMMARY Since the credit rating companies (Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings) have well-developed methodologies for analyzing the default risk of a corporate bond, we will […]

©2013 Pearson Education 453 CHAPTER 21 CREDIT RISK MODELING CHAPTER SUMMARY Credit risk models are used in finance to measure, monitor, and control a portfolio’s credit risk. In fixed-income analysis they are also used in the pricing of credit risky […]

CHAPTER 22 BOND PORTFOLIO MANAGEMENT STRATEGIES CHAPTER SUMMARY In this chapter we look at bond portfolio strategies where the benchmark by which a manager is evaluated is a bond index. Before we discuss bond portfolio management strategies in this chapter, […]

index was 4.05; however, it will change over time. The fund, in the aggregate, will seek to maintain a weighted average credit rating of A- or better, based on the weighted average credit quality of the fund’s portfolio securities. Individual […]

CHAPTER 23 BOND PORTFOLIO CONSTRUCTION CHAPTER SUMMARY In this chapter, we will see how to construct (build) portfolios. We begin with a brief review of the basic principles of the theory of portfolio selection and portfolio risk. Then we explain […]

Month 2001 Portfolio A’s Return Lehman Aggregate Bond Index Return Active Return Differences Squared January 2.15% 1.65% 0.50% 0.0707(%2) February 0.89% –0.10% 0.99% 0.5713(%2) March 1.15% 0.52% 0.63% 0.1567(%2) April –0.47% –0.60% 0.13% 0.0109(%2) May 1.71% 0.65% 1.06% 0.6820(%2) June […]

assets. Due to the relation between the modified duration and Macaulay duration, the modified duration analysis can be classified in terms of the latter. Manager C should agree with Manager B’s choice but should not agree that Manager B’s strategy […]

CHAPTER 24 LIABILITY-DRIVEN STRATEGIES CHAPTER SUMMARY In this chapter, we begin with the basic principles underlying the management ofassets relative to liabilities, popularly referred to as asset/liability management. We then describe several structured portfolio strategies, strategies that seek to match […]

CHAPTER 25 BOND PERFORMANCE MEASUREMENT AND EVALUATION CHAPTER SUMMARY In this chapter we will see how to measure and evaluate the investment performance of a fixed-income portfolio manager. Performance measurement involves the calculation of the return realized by a portfolio […]

(c) Is the average monthly rate of return of 33.33% indicative of the performance of Smith & Jones? If not, what would be a more appropriate measure? The 33.33% monthly rate of return is not indicative of the performance of […]

CHAPTER 26 INTEREST-RATE FUTURES CONTRACTS CHAPTER SUMMARY A futures contract is an agreement that requires a party to the agreement either to buy or sell something at a designated future date at a predetermined price. In this chapter we describe […]

The theoretical Treasury bond futures price may be at a premium to the cash market price (higher than the cash market price) or at a discount from the cash market price (lower than the cash market price), depending on (r […]

From the buyer’s point of view, the only cost with an option is the price of the option and that is the maximum amount that can be lost. With a futures contract much more can be lost plus the additional […]

CHAPTER 27 INTEREST-RATE OPTIONS CHAPTER SUMMARY In this chapter we explain the various types of interest-rate options, their applications to portfolio management, and how they are priced. OPTIONS DEFINED An optionis a contract in which the writer of the option […]

CHAPTER 28 INTEREST-RATE SWAPS, CAPS, AND FLOORS CHAPTER SUMMARY In Chapters 26 and 27, we discussed how interest-rate futures and options can be used to control interest-rate risk. There are other contracts useful for controlling such risk that commercial banks […]

then this involves the manager entering into a swap as the fixed-rate payer. It can be shown that the dollar duration for a notional amount of $7,699,779 is $340,881. Hence a 5-year interest-rate swap with that notional amount combined with […]

CHAPTER 29 CREDIT DEFAULT SWAPS CHAPTERSUMMARY In this chapter, we describe the different types of CDS, the basics of CDS valuation for a single-name CDS, and how a CDS can be used to control risk. We begin with the critical […]

make the new terms less attractive to the debt holder than the original terms. The terms that can be changed would typically include, but are not limited to, one or more of the following: (i) a reduction in the interest […]

CHAPTER 3 MEASURING YIELD CHAPTER SUMMARY In Chapter 2 we showed how to determine the price of a bond, and we described the relationship between price and yield. In this chapter we discuss various yield measures and their meaning for […]

(c) Suppose that the portfolio manager is managing the assets of a life insurance company that has issued a five-year guaranteed investment contract (GIC). The interest rate that the life insurance company has agreed to pay is 9% on a […]

$354.555664 / $98.2062 = 3.6103185 or about 3.61. Converting to annual number by dividing by two gives a modified duration of 1.805159 (before the increase in 100 basis points it was 1.814948). We next solve for the change in price […]

CHAPTER 4 BOND PRICE VOLATILITY CHAPTER SUMMARY The purpose of this chapter is twofold. First, we offer an explanation of the pricevolatility characteristics of a bond. Second, we present and illustrate several measures for quantifyingthe exposure of a position or […]

CHAPTER 5 FACTORS AFFECTING BOND YIELDS AND THE TERM STRUCTURE OF INTEREST RATES CHAPTER SUMMARY In this chapter we look at the factors that affect the yield offered in the bond market. We begin with the minimum interest rate that […]

Forward rates and spot rates are related because forward rates can be derived from spot rates. Forward rates are expected future spot rates that may differ from the actual spot rates that occur in the future. Spot rates can be […]

©2013 Pearson Education 127 CHAPTER 6 TREASURY AND FEDERAL AGENCY SECURITIES CHAPTER SUMMARY The second largest sector of the bond market (after the mortgage market) is the market for U.S. Treasury securities. One of the smallest sector is the U.S. […]

CHAPTER 7 CORPORATE DEBT INSTRUMENTS CHAPTER SUMMARY Corporate debt instruments are financial obligations of a corporation that have priority over its common stock and preferred stock in the case of bankruptcy. In this chapter we discuss the seniority of debt […]

6. What is meant by an issue or issuer being placed on a credit watch? Being placed on a credit watch means the issue or issuer is under review for a possible change in rating. Rating agencies monitor the bonds […]

©2013 Pearson Education 176 CHAPTER 8 MUNICIPAL SECURITIES CHAPTER SUMMARY Municipal securities are issued by state and local governments and by entities that they establish. All states issue municipal securities. Local governments include cities and counties. Political subdivisions of municipalities […]

CHAPTER 9 INTERNATIONAL BONDS CHAPTER SUMMARY This chapter covers international bond markets from the perspective of U.S. investors. U.S. investors have become increasingly aware of non-U.S. interest-rate movements and their relationship to U.S. interest rates. Foreign countries have liberalized their […]

3. “The strongest argument for investing in nondollar bonds is that there are diversification benefits.” Explain why you agree or disagree with this statement. There are mixed empirical findings for agreeing with the statement that diversification is the strongest argument […]