Q a schweser self test 07 fixed income portfolio management question

Use the following information for Questions 1 through 6.
John Wortek and Jack Benson are advisors with Pheifer Advisors, located in New York. Pheifer
provides investment advice to wealthy investors and institutional investors and has been doing
so for more than ten years. Pheifer has a full staff of analysts, traders, portfolio managers, and
economists.
The chief economist is Paul Worthington. Based on the Federal Reserve's latest Federal Open
Market Committee meeting minutes and a decrease in purchases of U.S. bonds by Chinese
investors, Worthington is forecasting an increase in U.S. interest rates. At the same time,
Worthington is also forecasting a slowdown in the economy, because he believes that the
Federal Reserve has been too aggressive in fighting inflation through increases in interest rates.
Wortek and Benson are in discussions with the Jane Sumner, the portfolio manager of the
defined benefit pension plan for Alpha Seed. Alpha is a firm that specializes in the production of
bio-engineered seed for farmers so that they can increase crop yield without using as many
costly insecticides. Alpha has been a publicly traded firm for just three years. Wortek has
calculated the duration of Alpha's liabilities to be approximately 12 years. Currently Alpha's
portfolio consists of large-cap U.S. stocks, bonds, and adjustable- rate mortgage-backed
securities.
Sumner is considering the addition of three bonds to Alpha Seed's pension plan. The bond prices
and their corresponding effective durations are as follows:

Bond
A
B
C

Price
95
90
85

Duration

4.5
6.0
7.8

Sumner would also like to keep the fixed-income portfolio structured so that it is dedicated to the
firm's obligations and is immunized against interest rate risk. Benson makes two statements
comparing a barbell to a bullet portfolio strategy.

Statement 1: The barbell will most likely outperform a bullet in a flattening yield curve
environment.
Statement 2: The barbell will most likely immunize a single period liability just as well as a
bullet portfolio.
Wortek and Benson also recommend more active strategies for their less risk-averse customers
who do not need to immunize against a liability. One strategy Wortek has had particular success
with is quality-spread analysis. Wortek describes quality spread analysis as the purchase of
bonds with a yield that is higher than that justified by its credit risk.


The appropriate yield spread is determined by examining the yields on high-quality and lowquality bonds. Benson suggests that a superior trading strategy would be to use percentage yield
spread analysis.
..........................................................................................................................................................

Question #1 of 6
Given Worthington's forecast of a general increase in interest rates and a slowing economy
(which would lead to widening credit spreads), the most appropriate analysis method for
corporate bonds would be:
A) total return analysis.
B) Wortek's quality spread analysis.
C) Benson's percentage yield spread analysis.

Question #2 of 6
Given the chief economist views on interest rates, the most appropriate strategy would be to:
A) Buy bond futures contracts on shorter maturity bonds.
B) Buy call options on bond contracts.
C) Buy interest rate caps.

Question #3 of 6
Given the chief economist's interest rate forecast and the information on the bonds Sumner is
considering for addition to the plan, calculate the dollar duration of Bond A for a 100-basis point
change in rates and determine what Sumner should do if she wishes to increase the dollar
duration of this bond.

Bond A

Increasing DD

A) $4.50

Sell futures contracts

B) $4.28

Buy futures contracts

C) $4.50

Buy futures contracts


Question #4 of 6

Sumner uses shortfall risk to measure the risk of the bonds in Alpha's pension plan. What is the
primary drawback that Sumner should be aware of when using this measure? Shortfall risk:
A) does not consider the magnitude of losses.
B) is difficult to compute for a large bond portfolio.
C) may not represent the risk measures that will be observed in the future.

Question #5 of 6
Regarding Benson's statements about barbell and bullet portfolios, which of the following is most
likely accurate?

Statement 1

Statement 2

A) Correct

Correct

B) Correct

Incorrect

C) Incorrect

Incorrect

Question #6 of 6
Regarding Wortek's and Benson's statements concerning active strategies for bonds:
A) one is correct.
B) both are incorrect.

C) both are correct.