FIXED INCOME INVESTMENTS ANALYSIS AUGUST 2023 PAST PAPER

MONDAY: 21 August 2023. Afternoon Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.

QUESTION ONE

1. In relation to currency denomination, explain the following types of bonds:

Dual currency bonds. (2 marks)

Currency options bonds. (2 marks)

2. Describe THREE factors that might affect a floater’s price. (6 marks)

3. Tausi Ltd. issued a term bond with a face value of Sh.1,000. The yield to maturity (YTM) of the bond is 10% and it has a coupon rate of 12% per annum. The bond coupon will be paid annually. The bond term to maturity is four years.

Required:

The price of the bond. (3 marks)

The Macaulay duration. (2 marks)

The Modified duration. (2 marks)

The bond convexity. (3 marks)

(Total: 20 marks)

 

QUESTION TWO

1. Describe FOUR advantages of bond refunding from the issuer’s perspective. (4 marks)

2. A treasury bill was sold at a price of Sh.99.479 per Sh.100 face value. At the date of issue, the bill had 182 days to maturity.

Required:
Determine the yield rate on a discount basis. (3 marks)

3. The following information on three newly issued AAA-rated bonds is provided:

Effective duration and effective convexity for various shifts in the term structure are as follows:

Required:

Evaluate which of the three bonds is:

Putable. (2 marks)

Callable. (2 marks)

Option-free. (2 marks)

4. A treasury bond pays 10% coupon annually. The bond has 53 days to the next coupon payment and there are 312 days since the last coupon payment. After the next coupon payment, the bond will have 6 years to maturity.

The current market yield for the bond is 9%. The par value of the bond is Sh.100.

Required:
Compute the following for the bond:

The accrued interest. (2 marks)

The dirty price. (3 marks)

The clean price. (2 marks)

(Total: 20 marks)

 

QUESTION THREE

1. Explain the following types of risks associated with fixed income securities:

Reinvestment risk. (2 marks)

Downgrade risk. (2 marks)

Event risk. (2 marks)

2. A corporate bond has three years to maturity and 12% coupon rate payable semi-annually. The bond is callable in two years at 105% of the face value. The bond is trading at Sh.980 currently and the face value is Sh.1,000.

Required:

Calculate:

The yield to maturity (YTM). (3 marks)

The yield to call. (3 marks)

3. Stephen Mwangangi is evaluating a portfolio of two option-free bonds, A and B with a face value of Sh.10 million each.

Additional information:
1. Bond A has a coupon rate of 10% with 5 years to maturity. The yield to maturity (YTM) of the bond is
8%.
2. Bond B has a coupon rate of 8% with 15 years to maturity. The YTM of the bond is 10%.
3. There was a parallel shift in the yield curve of +100 basis points.

Required:

The total current market value of the portfolio. (3 marks)

The total market value of the portfolio when yield increases by 100 basis points. (3 marks)

The interest rate exposure using the full valuation approach. (2 marks)

(Total: 20 marks)

QUESTION FOUR

1. Analyse THREE approaches used to gauge credit risk of a company. (6 marks)

2. An investor purchases a 5-year, 9% coupon bond that pays interest semi-annually. The price of this bond is Sh.108.32. The yield to maturity for the bond is 7% on a bond-equivalent basis. The face value of the bond is Sh.100.

Required:

Determine the following for this bond:

Total future value of money. (2 marks)

Capital gain/loss. (1 mark)

Reinvestment income. (3 marks)

3. The following treasury spot rate curve is provided:

A 10%, 2-year treasury bond is issued in the market based on the 2-year treasury yield of 6%. The par value of the bond is Sh.100.

Required:

The arbitrage free value of the bond. (3 marks)

The value of the bond using the traditional valuation approach. (3 marks)

The arbitrage profit. (2 marks)

(Total: 20 marks)

 

QUESTION FIVE

1. Explain THREE determinants of the nominal yield curve of a fixed income security. (6 marks)

2. Consider the following spot rates:

Required:

The 6-month forward rate one year from now. (3 marks)

The 1-year forward rate one year from now. (3 marks)

3. A 5.25% corporate bond with three years to maturity is putable in one year at Sh.100 par value. The interest rate today is 3.5% and goes up to 4.976% and down to 4.074% in period 1. Interest rate movements are 6.757%, 5.532% and 4.53% in period 2.

Required:

Draw a binomial tree and establish the value of the putable bond today. (6 marks)

If the value of the non-putable corresponding bond is Sh.102.075, determine the put option value.
(2 marks)

(Total: 20 marks)

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