"Fixed Income Investments":Defining Elements

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Questions 1:

If an issuer is required to retire a specified portion of the bond’s principal each year, the bond most likely:

A、 is callable.

B、 is a step-up note.

C、 has a sinking fund provision.

Questions 2:

The Delfain Corporation reported a significant improvement in profitability that was followed by a material upgrade in its credit rating. The market responded by immediately requiring a 100 basis point narrower spread to Gilts on Delfain’s 8-year bond. If the bond’s modified duration is 6.0 and its convexity is 55.0, the return impact of this change is closest to:

A 、6.28%.

B 、–5.73%.

C、 7.10%

View answer resolution

【Answer to question 1】C

【analysis】

C is correct. A sinking fund provision requires retirement of a portion of the bond’s principal every year, rather than retirement of the entire issue at maturity. A is incorrect because a bond that is currently callable may be retired by the issuer, but the issuer is not required to do so. B is incorrect because a step-up note has a coupon rate that increases over time according to a predetermined schedule

【Answer to question 2】A

【analysis】

A is correct. The return impact of a 60 bps fall in the bond’s yield can be computed as: