Risks Associated With Investing In Bonds

Question 1

Interest rate risk

Answer 1

When the price of a bond held in a portfolio declines because of the rise in market interest rates

Question 2

Reason for an inverse relationship between changes in interest rates and bond prices

Answer 2

If interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price

Question 3

Corporate rate less than yield required by market

Answer 3

price less than par value
Par value

Question 4

Corporate rate greater than yield required by market

Answer 4

Price is greater than par value
premium

Question 5

Impact of maturity

Answer 5

The longer the bonds maturity, the greater the bond’s price sensitivity to changes in interest rates

Question 6

Impact of coupon rate

Answer 6

The lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates

Question 7

Impact of embedded options

Answer 7

Change depending on how the value of the embedded options changes when interest rate changes

Question 8

Embedded call option

Answer 8

A benefit to the issuer and a disadvantage to the bondholder
subtracted from the option free Bond

Question 9

Option free Bond

Answer 9

Once the embedded call option is deducted, it increases when interest rates decline

Question 10

Duration

Answer 10

A measure of the price sensitivity of a bond to a change in yield

Question 11

Yield Curve risk

Answer 11

Affect the price sensitivity of a portfolio of bonds
an adverse shift in market interest rates

Question 12

Impact of yield level

Answer 12

The higher the bond yield, the lower the price sensitivity

Question 13

Measuring interest rate risk

Answer 13

Percentage price change from initial price
dollar price change from initial price change

Question 14

Rate shock

Answer 14

Change in yield basis points

Question 15

Call risk

Answer 15

The risk for a bond buyer that exists in purchasing a callable bond

Question 16

Prepayment risk

Answer 16

The risk involved with the premature return of principal on a fixed income security

Question 17

Reinvestment risk

Answer 17

The possibility that an investor will be unable to reinvest cash flows received from an investment

Question 18

Types of credit risks

Answer 18

Default risk
credit spread risk
downgrade risk

Question 19

Default risk

Answer 19

The risk that an issuer will fail to satisfy the terms of the obligation with respect to timely payments

Question 20

Credit spread rate

Answer 20

The risks that an issuers debt obligation would decline due to an increase in credit spread

Question 21

Rating agency

Answer 21

A tool investors used to gauge the default risk of an issue is the credit ratings assigned to issues by rating company

Question 22

Downgrade

Answer 22

A deterioration in the credit rating of an issue is penalized by the inferior credit rating

Question 23

Upgrade

Answer 23

Improvement in the credit quality of an issue is rewarded with a better credit rating

Question 24

Liquidity risk

Answer 24

The risk that the Investor will have to sell a bond below its indicated value

Question 25

Currency risk

Answer 25

The risk of receiving less of the domestic currency when investing in a bond that makes payment in another currency

Question 26

Inflation risk

Answer 26

Arises from the decline in the value of the security cash flow

Question 27

Volatility risk

Answer 27

The risk that at the price of a bond with an embedded option will decline when a yield volatility changes

Question 28

Volatility risk on options

Answer 28

Callable bonds: increase an expected yield volatility
Putable bonds: decrease in expected yield volatility

Question 29

Event risk

Answer 29

Natural disaster
take over/corporate restructuring
regulatory change

Question 30

Forms of sovereign risk

Answer 30

Unwillingness of the government to pay
inability to pay due to unfavorable economic conditions

Question 31

What causes credit spread to widen

Answer 31

Worsening credit cycle
Weak macroeconomic climate
Decline in financial climate
Lack of market makers (brokers-dealers)
Insufficient demand for bond issue
Credit downgrades
Falling liquidity