CFA Level 1 - Fixed Income Session 16 - Reading 66 - LOS f

CFA Level 1 - Fixed Income Session 16 - Reading 66 - LOS f (Notes, Practice Questions, Sample Questions) 1. Which of the following statements regarding the option adjusted spread (OAS) is least accurate? The option adjustedspread: A) is the spread added to the Treasury spot rate curve that thebond would have if it were option-free.B) is the spread that accounts for non-option characteristics likecredit risk, liquidity risk, and interest rate risk. C) for a putable bond is the Z-spread minus the cost of theoption. Explanation: C — Since the buyer of a putable bond must payextra for the put option, the OAS spread for a putable bond isthe Z-spread plus the put option cost in percent 2. The zero volatility spread (Z-spread) is the spread that: A) is added to the yield to maturity of a similar maturity Treasurybond to equal the yield to maturity of the risky bond.B) results when the cost of the call option in percent is subtractedfrom the option adjusted spread. C) is added to each spot rate on the Treasury yield curve thatwill cause the present value of the bond's cash flows to equalits market price

Explanation: C — The zero volatility spread (Z-spread) is theinterest rate that is added to each zero-coupon bond spot ratethat will cause the present value of the risky bond's cash flowsto equal its market value. The nominal spread is the spreadthat is added to the YTM of a similar maturity Treasury bondthat will then equal the YTM of the risky bond. The zerovolatility spread (Z-spread) is the spread that results when thecost of the call option in percent is added to the optionadjusted spread 3. One of the most commonly used yield spread measures is the nominal spread. Which of the following is a limitation of nominalspread? The nominal spread assumes: A) an upward sloping yield curve.B) all coupon payments are reinvested at a rate equal to the riskfree rate. C) a flat yield curve Explanation: C — The nominal spread is easy to calculate – itis simply the yield to maturity on a bond minus the yield tomaturity on a Treasury security of a similar maturity. Becausethe nominal yield is based on the yield to maturity, it su ersthe same shortcomings as yield to maturity. The yieldmeasures assume that all cash flows can be discounted at thesame rate (i.e., assumes a flat yield curve). They also assumethat all coupon payments will be received in a prompt andtimely fashion, and reinvested to maturity, at a rate of returnthat is equal to the appropriate solving rate (i.e., the bond’sYTM or its BEY)

4. One of the most commonly used yield spread measures is the nominal spread. Which of the following is NOT a limitation ofnominal spread? The nominal spread: A) assumes a flat yield curve. B) is di cult to calculate. C) assumes all cash flows can be discounted at the same rate Explanation: B — The nominal spread is easy to calculate – itis simply the yield to maturity on a bond minus the yield tomaturity on a Treasury security of a similar maturity. Becausethe nominal yield is based on the yield to maturity, it su ersthe same shortcomings as yield to maturity. The yieldmeasures assume that all cash flows can be discounted at thesame rate (i.e., assumes a flat yield curve). They also assumethat all coupon payments will be received in a prompt andtimely fashion, and reinvested to maturity, at a rate of returnthat is equal to the appropriate solving rate (i.e., the bond'sYTM or its BEY) 5. The zero volatility spread (Z-spread) is the spread that: A) is added to the yield to maturity of a similar maturity Treasurybond to equal the yield to maturity of the risky bond.B) results when the cost of the call option in percent is subtractedfrom the option adjusted spread. C) is added to each spot rate on the Treasury yield curve thatwill cause the present value of the bond's cash flows to equalits market price Explanation: C — The zero volatility spread (Z-spread) is theinterest rate that is added to each zero-coupon bond spot ratethat will cause the present value of the risky bond's cash flows

to equal its market value. The nominal spread is the spreadthat is added to the YTM of a similar maturity Treasury bondthat will then equal the YTM of the risky bond. The zerovolatility spread (Z-spread) is the spread that results when thecost of the call option in percent is added to the optionadjusted spread 6. One of the most commonly used yield spread measures is the nominal spread. Which of the following is least likely a limitationof nominal spread? The nominal spread assumes: A) all cash payments will be received in a prompt and timelymanner. B) an upward sloping yield curve. C) all cash flows can be discounted at the same rate Explanation: B — The nominal spread is easy to calculate – itis simply the yield to maturity on a bond minus the yield tomaturity on a Treasury security of a similar maturity. Becausethe nominal yield is based on the yield to maturity, it su ersthe same shortcomings as yield to maturity. The yieldmeasures assume that all cash flows can be discounted at thesame rate (i.e., assumes a flat yield curve). They also assumethat all coupon payments will be received in a prompt andtimely fashion, and reinvested to maturity, at a rate of returnthat is equal to the appropriate solving rate (i.e., the bond’sYTM or its BEY)