Fixed Income - Fixed Income Section 2

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1. Mr. Harris is a buy-and-hold investor who mainly deals in fixed income securities. What will be the most likely impact on the returns of his fixed income portfolio, if the market interest rates are lower in future?

  • Option : C
  • Explanation : In a buy-and-hold strategy if the market interest rates are lower in the future, the returns will decrease because the reinvestment income will decrease.
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3. If a bond, bought at a discount, is held to maturity; which of the following is least likely to be incorporated for the total return calculation?

  • Option : A
  • Explanation : When a bond is held to maturity, there is no capital gain or loss because the carrying value of the bond at maturity is the same as the redemption amount.
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4. A & B are two identical bonds except for their coupon rates. The bond that will have the lowest interest rate risk most likely has the:

  • Option : B
  • Explanation : A higher coupon rate means that more of the bond's value comes from coupon and less from the market interest rate.
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5. An investor purchased 9% annual pay bond with maturity of 3 years and face value of $1,000 at the current market price of $1,025.78. The investor plans to hold the bond till maturity. What is the expected annualized holding period return? What is the future value of reinvested coupons?

  • Option : B
  • Explanation : Annualized holding period return is the IRR of the investment:
    N = 3, PV = -1,025.78, PMT = 90, FV = $1,000, CPT I/Y. I/Y = 8%.
    The total portion of coupon payments and reinvestment return 90(1.08)² + 90(1.08) + 90 = $292.18.
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