The following information assumes that the CFA Institute Code of Ethics and Standards are applicable.
1. Serena currently holds shares of company PQT. However, she is not sure whether this is the right time for her to sell a portion of them or she should increase holding of PQT in her portfolio. Her friend, Jaden is a financial advisor for PQT. Serena approaches Jaden for some advice. Jaden tells her that the Food and Drug Administration (FDA) has not approved the company’s new drug and she should sell its shares immediately before this information is announced to the public. Please explain which of the following two standards are most likely in violation? [5 marks]
A. II (A) Material nonpublic information
B. III (E) Preservation of Confidentiality
C. VI (A) Disclosure of Conflicts
D. III (B) Performance Presentation
2. James recently short sold shares of company KYT. He attempts to drive down the stock price by issuing false negative information regarding the company through YouTube channels and advising subscribers to reduce their investments in KYT. Please explain which of the following standards did James most likely violate: [2 marks]
A. III(C) Suitability
B. II (A) Material nonpublic information
C. I(D) Misconduct
D. IV (A) Loyalty
3. Paul is an investment manager. He noticed that company SRT’s share price has been increasing over the past few days. Paul followed this trend and reshuffled his client’s portfolio by replacing 30% of the portfolio with shares of SRT. However, his action was not documented. Please explain which standard did Paul most likely violate? [2 marks]
A. II (B) Market Manipulation
B. V (C) Record Retention
C. III (B) Fair Dealing
D. III (A) Loyalty, Prudence and Care
4. Winona recommends the purchase of a mutual fund that invests solely in long-term US Treasury bonds. She makes the following statements to her clients:
I. “If you invest in the mutual fund, you will earn a 10% rate of return each year for the next several years based on historical performance of the market.”
II. “The payment of the bonds is guaranteed by the US government; therefore, the default risk of the bonds is virtually zero.”
Did Winona’s statements violate the CFA Institute Code and Standards? Which standard did Winona violate? [3 marks]
A. Neither statement violated the Code and Standards
B. Only statement I violated the Code and Standards
C. Only statement II violated the Code and Standards
5. Ethics play an important part in the business-world, and this is particularly true for the investment industry. You may often be placed in situations where you must make decisions where you face conflicting interests. Recommend, and explain, a decision-making framework that may guide you towards making an ethical decision. [3 marks]
SECTION B: Fixed Income (55 marks total).
Please type your answers in this blank space provided after the question. For calculations please round your final answer to two decimal places, round any intermediary calculations to four decimal places. For follow through marks you must show all workings.
Question 1 (15 marks)
A. You are an investment consultant working for a superannuation firm. One of the fixed-income portfolio managers wants to understand more about managing interest rate risk in the portfolio, and she is particularly interested in understanding the concept of duration. The portfolio currently contains option free bonds but the manager is considering adding bonds with embedded options into the portfolio. The manager is also considering purchasing a three-year 5% annual coupon paying bond.
Using the par rates for annual coupon sovereign debt in the figure below and bootstrapping method to obtain the 2-year, 3-year and 4-year spot rates.[6 marks]
B. You are considering purchasing a bond between settlement periods with a 9% coupon rate and 5 semi-annual coupon payments remaining. There are 182 days in the coupon period and the days between the last coupon period and the settlement date is 66. What is the dirty price for this bond if a discount rate of 8% is used? [6 marks]
C. Rank the following bonds by their price volatility if interest rates increase by 1%. Where rank 1 is highest price volatility. [3 marks]
Maturity Annual Coupon Rank
Bond A 3 years 4%
Bond B 3 years 2%
Bond C 6 years 2%
Question 2 (20 marks)
A. U.S. corporation decides to issue two bonds in the Australian market:
• Bond NYS which is a Eurobond.
• Bond NUT which is a Foreign bond.
Please fill in the blanks below.
Bond NYS should not be denominated in (which currency?) when it is issued and bond NUT should be denominated in (which currency? [2 Marks]
B. The relationship between bond prices and yields is very important to fixed-income investors. Compare and contrast the price/yield and price/volatility relationships of a callable and option free bond. [8 marks]
C. Assume that bonds X, T and U all have the same maturity.
Based on the table below, what pattern do you observe in the estimated vs. actual percentage changes in bond price when interest rate changes? What is the best terminology to describe this pattern (use terminology covered in this unit) and what relationship between bond prices and interest rates does this pattern imply? Please explain your answers. [5 Marks]
Estimated percentage change in price if interest rates change by: Actual percentage change in price if interest rates change by:
-20 basis points +20 basis points -20 basis points +20 basis points
Bond S +12% -9% +12.12% -8.88%
Bond Y +7% -4% +7.05% -3.95%
Bond L +9% -6% +9.08% -5.92%
D. Lenora current holds a 10-year maturity bond. She decides to sell her bond at the end of her investment horizon, which is before the maturity of the bond. The bond has a Macaulay duration of 7 years. Based on the What-if analysis results presented in the table below, is Lenora’s investment horizon longer than the 7 years, less than 7 years, or equal to 7 years?
Does coupon reinvestment risk matter more to Lenora, or market price risk matters more, or almost no interest rate risk to Lenora over her investment horizon? Please explain your answers. [5 Marks]
Lenora’s bond YTM (%) FV of reinvested coupon at the end of investment horizon Bond’s price if sold at the end of investment horizon FV of reinvested coupon plus sale price of bond at the end of investment horizon
Scenario 1 9.00% $73.60 $97.47 $171.07
Scenario 2 6.00% $67.15 $105.35 $172.50
Scenario 3 12.00% $80.71 $90.39 $171.10
Question 3 (20 marks)
Figure below presents the spot yield curves for different scenarios. Please use it to answer parts A and B.
A. Using yield curve from Scenario 4, which of the three curves: par curve, spot curve and forward curve is the lowest before year 6? How would you expect the forward curve to change at year 7 relative to the spot curve (i.e. lie above or below). Please explain your answers. [2 marks]
B.Based on the yield curve under Scenario 3, if it also included a positive liquidity premium, what would you expect this yield curve to look like compared to the same yield curve without a positive liquidity premium? Please explain your answers. [3 marks]
C. Given the data in the table and the information below, please answer the following parts. Show all working and formulas used.
Maturity (T) r(1) r(2) r(3) r(4) r(5) r(6)
Spot Rate (%) 0.05 0.28 0.12 0.03
The forward rate for a 3-year loan beginning in 2 years is 0.067%. The forward rate for a 2-year loan starting in 3 years is -0.194%.
1) Please calculate the 3-year spot rate. [2 marks]
2) Please calculate the 2-year spot rate. [2 marks]
3) Misty would like to invest $10,000 today. She is faced with the choice between 2 investments:
Option 1: invest $10,000 today for 5 years;
Option 2: invest $10,000 today for 1 year and reinvest proceeds for another 4 years at a forward rate of 0.10%
Which one is the optimal option to Misty, or she should be indifferent between the choices? [3 marks]
D. Covid-19 has led to the global contraction. Considering the negative impact of covid-19 on financial markets, how would this affect the credit rating if a company decides to issue debt in the market? Please explain it in terms of factors such as probability of default, recovery rate, credit spread or migration. [4 marks]
E. “Four Cs of credit analysis” is used by analysts to evaluate creditworthiness. For each of the following scenarios, which of the “Four Cs” should be used for evaluation? Please also explain your answers.
Scenarios Which of the “Four Cs”
1. Company GDP decides to issue debt. However, it operates in an industry with 15 competitors, and it only has a market share of 2%. Investors are concerned with GDP’s ability to maintain stable cash flows over time.
2. Management of Company ATT decides to issue debt. However, the management can only do so if company’s debt ratio is lower than 0.7.