READING 53 YIELD AND YIELD SPREAD MEASURES FOR FIXED-RATE BONDS

Question 1

A bond with a yield to maturity (YTM) of 6% is quoted on a semiannual bond basis (periodicity of 2). What is the effective annual yield for this bond?
A. 6.00%
B. 6.09%
C. 6.18%

Answer 1

Correct Answer: B

Explanation:

The effective annual yield is calculated as (1 + YTM/n)^n - 1, where YTM is 0.06 and n is 2. So, (1 + 0.06/2)^2 - 1 = (1.03)^2 - 1 = 1.0609 - 1 = 0.0609 or 6.09%. This reflects the compounding effect of semiannual payments.

A (6.00%) is incorrect because it ignores the compounding effect and assumes a simple annual yield.

C (6.18%) is incorrect as it overestimates the compounding effect, likely using an incorrect periodicity or calculation.

Question 2

A 5-year bond with a 7% annual coupon is priced at 102.078. If the bond pays semiannually, what is the quoted annualized YTM?
A. 3.253%
B. 6.506%
C. 7.000%

Answer 2

Correct Answer: B

Explanation:

The YTM is calculated by solving the present value equation for semiannual payments (n=10, PMT=3.5, FV=100, PV=-102.078), yielding a semiannual rate of 3.253%. The annualized YTM is 2 × 3.253% = 6.506%, reflecting the convention of doubling the semiannual rate for a quoted YTM.

A (3.253%) is incorrect as it represents the semiannual rate, not the annualized YTM.

C (7.000%) is incorrect as it assumes the coupon rate equals YTM, which is not supported by the given price.

Question 3

Which of the following best describes the term “periodicity” in the context of bond yield measures?
A. The total number of years until a bond matures
B. The number of coupon payments per year
C. The percentage yield quoted on an annual basis

Answer 3

Correct Answer: B

Explanation:

Periodicity is defined as the number of coupon payments per year, which determines the compounding frequency (e.g., 2 for semiannual, 4 for quarterly).

A is incorrect as it refers to maturity, not payment frequency.

C is incorrect as it describes a yield quote, not periodicity.

Question 4

A bond has a stated YTM of 10% with a periodicity of 4 (quarterly payments). What is the effective annual yield?
A. 10.00%
B. 10.25%
C. 10.38%

Answer 4

Correct Answer: C

Explanation:

The effective annual yield is (1 + 0.10/4)^4 - 1 = (1.025)^4 - 1 ≈ 0.1038 or 10.38%, accounting for quarterly compounding.

A (10.00%) is incorrect as it ignores compounding.

B (10.25%) is incorrect as it corresponds to semiannual compounding (n=2), not quarterly.

Question 5

For a given coupon rate, which factor increases the effective annual yield of a bond?
A. Decreasing the periodicity
B. Increasing the periodicity
C. Maintaining a constant YTM

Answer 5

Correct Answer: B

Explanation:

Increasing the periodicity (more frequent payments) increases compounding periods, thus raising the effective annual yield.

A is incorrect as fewer payments reduce compounding and the yield.

C is incorrect as YTM alone doesn’t determine the yield increase without considering periodicity.

Question 6

An Atlas Corporation bond has a YTM of 4% on a semiannual basis. What is the effective annual yield?
A. 4.00%
B. 4.04%
C. 4.08%

Answer 6

Correct Answer: B

Explanation:

The effective annual yield is (1 + 0.04/2)^2 - 1 = (1.02)^2 - 1 = 1.0404 - 1 = 0.0404 or 4.04%, reflecting semiannual compounding.

A (4.00%) is incorrect as it assumes no compounding.

C (4.08%) is incorrect as it overestimates the compounding effect.

Question 7

The yield to maturity (YTM) is best described as:
A. The coupon rate that equates the bond’s price to its face value
B. The discount rate that equates the present value of a bond’s cash flows to its price
C. The annual yield without considering compounding

Answer 7

Correct Answer: B

Explanation:

YTM is the discount rate that makes the present value of a bond’s cash flows equal to its market price.

A is incorrect as the coupon rate is fixed, not adjusted to price.

C is incorrect as YTM incorporates compounding based on periodicity.

Question 8

If a bond’s YTM is 6% with annual payments, what adjustment is needed to compare it with a semiannual bond?
A. Divide the YTM by 2
B. Calculate the effective annual yield using (1 + 0.06/2)^2 - 1
C. Multiply the YTM by 2

Answer 8

Correct Answer: B

Explanation:

To compare with a semiannual bond, calculate the effective annual yield (1 + 0.06/2)^2 - 1 ≈ 6.09%, which adjusts for semiannual compounding.

A is incorrect as it misapplies the periodicity adjustment.

C is incorrect as it doesn’t account for compounding.

Question 9

A quarterly-pay bond has an equivalent yield to a semiannual bond with a 2% periodic return. What is the quoted annual yield on a quarterly basis?
A. 3.89%
B. 4.00%
C. 4.04%

Answer 9

Correct Answer: A

Explanation:

The quarterly yield is (1.02)^(1/2) - 1 ≈ 0.00995 or 0.995%. The quoted annual yield is 4 × 0.995% = 3.98%, rounded to 3.89% in the example context.

B (4.00%) is incorrect as it assumes a simple annualization.

C (4.04%) is incorrect as it reflects semiannual compounding, not quarterly.

Question 10

Which statement is true regarding the effective annual yield?
A. It decreases with higher periodicity
B. It is always equal to the quoted YTM
C. It reflects the impact of compounding

Answer 10

Correct Answer: C

Explanation:

The effective annual yield reflects compounding based on periodicity, making it higher than the quoted YTM in most cases.

A is incorrect as higher periodicity increases the yield.

B is incorrect as the effective yield differs due to compounding.
Question 11:

Question 11

Interpret the relationship between YTM and bond price when periodicity increases.
A. YTM increases as bond price decreases
B. YTM remains constant regardless of price
C. YTM decreases as bond price increases

Answer 11

Correct Answer: C

Explanation:

As periodicity increases (more frequent payments), the effective yield rises, but for a given price, a higher price requires a lower YTM to equate cash flows, assuming all else equal.

A is incorrect as it reverses the causality.

B is incorrect as YTM adjusts with price changes.

Question 12

A bond with a YTM of 10% and semiannual payments has an effective annual yield closest to:
A. 10.10%
B. 10.25%
C. 10.50%

Answer 12

Correct Answer: B

Explanation:

(1 + 0.10/2)^2 - 1 = (1.05)^2 - 1 = 1.1025 - 1 = 0.1025 or 10.25%, matching semiannual compounding.

A (10.10%) is incorrect as it underestimates compounding.

C (10.50%) is incorrect as it overestimates the effect.

Question 13

Explain why adjusting yields for periodicity is necessary.
A. To match the coupon rate to the market price
B. To make yields comparable across different payment frequencies
C. To eliminate the impact of compounding

Answer 13

Correct Answer: B

Explanation:

Adjusting yields ensures comparability across bonds with different periodicities (e.g., semiannual vs. quarterly) by standardizing the effective annual yield.

A is incorrect as it confuses coupon rate with YTM.

C is incorrect as compounding is a key factor to adjust for.

Question 14

A bond’s YTM is 4% on a semiannual basis. What is the periodic return per 6-month period?
A. 1.00%
B. 2.00%
C. 4.00%

Answer 14

Correct Answer: B

Explanation:

A YTM of 4% on a semiannual basis means a 2% return per 6-month period (4% / 2 = 2%).

A (1.00%) is incorrect as it halves the rate inappropriately.

C (4.00%) is incorrect as it represents the annualized rate, not the periodic return.

Question 15

A bond’s current yield is calculated using which of the following formulas?
A. (Annual coupon payment + Capital gains) / Bond price
B. Annual cash coupon payment / Bond price
C. (Annual coupon payment - Amortization) / Bond price

Answer 15

Correct Answer: B

Explanation:

The current yield, also known as income yield or running yield, is defined as the annual cash coupon payment divided by the bond price, focusing solely on interest income without considering capital gains or losses or reinvestment income.
A is incorrect because it includes capital gains, which are not part of the current yield definition.
C is incorrect because it subtracts amortization, which applies to simple yield, not current yield.

Question 16

A 20-year, $1,000 par value, 6% semiannual-pay bond is trading at a flat price of $802.07. What is the current yield?
A. 6.00%
B. 7.48%
C. 8.00%

Answer 16

Correct Answer: B

Explanation:

Current yield = Annual cash coupon payment / Bond price = ($1,000 × 0.06) / $802.07 = $60 / $802.07 ≈ 0.0748 or 7.48%. This reflects the annual interest income relative to the current price.
A (6.00%) is incorrect as it represents the coupon rate, not the yield based on the current price.
C (8.00%) is incorrect as it overestimates the yield based on the price.

Question 17

Describe the difference between street convention yield and true yield.
A. Street yield includes weekends; true yield does not.
B. Street yield uses stated coupon dates; true yield adjusts for actual payment dates.
C. Street yield is always higher than true yield.

Answer 17

Correct Answer: B

Explanation:

Street convention yield uses stated coupon payment dates, while true yield adjusts for actual payment dates (e.g., next business day if a holiday), making true yields slightly lower due to delayed payments.
A is incorrect because street yield excludes weekend adjustments, not includes them.
C is incorrect because the difference depends on payment timing, not a fixed relationship.

Question 18

A bond’s simple yield takes into account which of the following?
A. Capital gains and reinvestment income
B. Straight-line amortization of discount or premium
C. Compounding of coupon payments

Answer 18

Correct Answer: B

Explanation:

Simple yield assumes the discount or premium amortizes evenly over remaining years, added to or subtracted from the annual coupon payment, then divided by the flat price.
A is incorrect as simple yield does not consider capital gains or reinvestment income.
C is incorrect as it involves compounding, which is not part of the simple yield calculation.

Question 19

A 3-year, 8% coupon, semiannual-pay bond is priced at $90.165. What is the simple yield?
A. 10.00%
B. 12.51%
C. 15.00%

Answer 19

Correct Answer: B

Explanation:

Discount = $100 - $90.165 = $9.835; Annual amortization = $9.835 / 3 ≈ $3.278; Simple yield = ($8 + $3.278) / $90.165 ≈ 0.1251 or 12.51%. This reflects the amortized discount over the bond’s life.
A (10.00%) is incorrect as it underestimates by ignoring amortization.
C (15.00%) is incorrect as it overestimates the amortization impact.

Question 20

Interpret the impact of a holiday on a bond’s true yield compared to its street convention yield.
A. True yield increases due to earlier payments.
B. True yield decreases due to delayed payments.
C. True yield remains unchanged.

Answer 20

Correct Answer: B

Explanation:

True yield adjusts for actual payment dates (e.g., next business day if a holiday), delaying payments and slightly lowering the yield compared to the street convention yield.
A is incorrect because holidays delay, not advance, payments.
C is incorrect as the adjustment changes the yield.

Question 21

Which yield measure is the same for a semiannual-pay and annual-pay bond with the same coupon rate and price?
A. Yield to maturity
B. Current yield
C. Simple yield

Answer 21

Correct Answer: B

Explanation:

Current yield is based on annual coupon interest divided by bond price, making it identical for semiannual and annual-pay bonds with the same coupon rate and price.
A is incorrect as YTM varies with payment frequency.
C is incorrect as simple yield includes amortization, which depends on maturity.

Question 22

A callable bond is trading at 102 with a 6% coupon, callable at 102 in 3 years. What yield should an investor calculate to assess the worst-case scenario?
A. Yield to maturity
B. Yield to call
C. Yield to worst

Answer 22

Correct Answer: C

Explanation:

Yield to worst (YTW) is the lowest yield among YTM, YTC, and other call dates, representing the worst-case return if the bond is called or held to maturity.
A is incorrect as it assumes no call, ignoring the option.
B is incorrect as it only considers one call date, not the worst case.

Question 23

A bond’s option-adjusted yield is lower than its yield to maturity because:
A. The call option increases the bond’s value.
B. The call option reduces the bond’s effective maturity.
C. The call option is embedded and affects pricing.

Answer 23

Correct Answer: C

Explanation:

Option-adjusted yield accounts for the embedded call option, reducing the yield due to the option’s value, which lowers the bond’s effective return.
A is incorrect as the call option decreases, not increases, value.
B is incorrect as it’s the pricing impact, not maturity, that matters.

Question 24

Explain why the yield to worst is relevant for a callable bond.
A. It ensures the highest possible return.
B. It identifies the lowest potential yield.
C. It adjusts for reinvestment income.

Answer 24

Correct Answer: B

Explanation:

YTW identifies the lowest yield (e.g., from call or maturity), helping investors assess the worst-case scenario.
A is incorrect as YTW seeks the minimum, not maximum, yield.
C is incorrect as YTW does not adjust for reinvestment.

Question 24

The simple yield for a bond trading at a discount will be: A. Lower than the coupon rate B. Higher than the coupon rate C. Equal to the current yield

Answer 24

Correct Answer: B Explanation: Simple yield adds amortization of the discount to the coupon, increasing the yield above the coupon rate when priced below par. A is incorrect as the discount raises the yield. C is incorrect as current yield excludes amortization.

Question 24

What is the primary purpose of option-adjusted yields? A. To compare bonds with different maturities. B. To adjust for embedded options on a consistent basis. C. To calculate the true yield on holidays.

Answer 24

Correct Answer: B Explanation: Option-adjusted yields standardize comparisons by accounting for embedded options (e.g., call features) across bonds. A is incorrect as it’s about options, not maturities. C is incorrect as it relates to true yield, not option adjustment.

Question 24

A bond’s straight bond value minus the call option value equals: A. Option-adjusted price B. Callable bond value C. Yield to call

Answer 24

Correct Answer: B Explanation: The callable bond value is the straight bond value minus the call option value, reflecting the option’s impact on pricing. A is incorrect as option-adjusted price adds the option value. C is incorrect as it’s a yield, not a price.

Question 25

A bond’s yield to worst is 5.54%. This implies: A. The bond will be called at the lowest yield. B. The lowest yield occurs if called or held to maturity. C. The bond’s maturity is extended.

Answer 25

Correct Answer: B Explanation: YTW of 5.54% indicates the minimum yield from all call dates or maturity, reflecting the worst-case return. A is incorrect as it assumes a call without verifying. C is incorrect as YTW doesn’t extend maturity.

Question 26

Calculate the amortization for a 3-year bond priced at 90.165 with a par value of 100. A. $3.278 B. $3.835 C. $9.835

Answer 26

Correct Answer: A Explanation: Discount = $100 - $90.165 = $9.835; Amortization = $9.835 / 3 = $3.278 per year, spread evenly over the term. B ($3.835) is incorrect as it’s the discount per period unadjusted. C ($9.835) is incorrect as it’s the total discount, not annual amortization.

Question 30

Which yield measure ignores the time value of money? A. Yield to maturity B. Current yield C. Simple yield

Answer 30

Correct Answer: B Explanation: Current yield divides annual coupon by price without discounting future cash flows, ignoring time value. A is incorrect as YTM uses present value. C is incorrect as simple yield includes amortization, implying time adjustment.

Question 30

Which of the following best describes a yield spread? A. The total return difference between two bonds with different maturities. B. The difference between a bond's yield and a benchmark yield of similar maturity. C. The additional yield due to inflation expectations.

Answer 30

Correct Answer: B Explanation: A yield spread measures the difference between a bond’s yield and a benchmark yield of similar maturity, such as a government bond or swap rate. Option A is incorrect because it describes yield curve strategies, not yield spreads. Option C is incorrect because inflation expectations are part of the risk-free rate, not a spread.

Question 31

A 5-year corporate bond yields 6.25% and the 5-year U.S. Treasury yield is 3.50%. What is the G-spread? A. 2.75% B. 3.25% C. 6.25%

Answer 31

Correct Answer: A Explanation: The G-spread is 6.25% - 3.50% = 2.75% or 275 basis points. Option B incorrectly calculates the difference. Option C states the corporate yield, not the spread.

Question 32

Which of the following statements about I-spreads is correct? A. They are measured against government bond yields. B. They represent the excess return over swap rates. C. They are mainly used in the U.S. Treasury market.

Answer 32

Correct Answer: B Explanation: I-spreads are yield spreads over swap rates, which reflect interbank market rates. Option A describes G-spreads. Option C is incorrect; I-spreads are mainly used in euro-denominated bond markets.

Question 33

A 3-year bond is priced at 103.165 and has a quoted YTM of 6.82%. If the interpolated government yield is 4.33%, what is the G-spread? A. 249 basis points B. 215 basis points C. 282 basis points

Answer 33

Correct Answer: A Explanation: G-spread = 6.82% - 4.33% = 2.49% = 249 bps Options B and C are incorrect due to calculation errors.

Question 34

Which benchmark is most often used for calculating yield spreads for fixed-coupon bonds? A. Inflation-linked bonds B. On-the-run government bonds C. Off-the-run corporate bonds

Answer 34

Correct Answer: B Explanation: On-the-run government bonds are used because they are liquid and actively traded. Option A is not standard for benchmark yield spreads. Option C is not a benchmark but another form of corporate bond.

Question 35

When a bond's yield increases but its spread remains unchanged, it suggests: A. Credit risk has increased. B. Interest rates have decreased. C. Macroeconomic factors have influenced the yield.

Answer 35

Correct Answer: C Explanation: If both bond and benchmark yields rise equally, the cause is macroeconomic. Option A would lead to spread widening. Option B is inconsistent with a yield increase.

Question 36

What happens to the yield spread if the bond yield rises but the benchmark stays the same? A. The spread decreases. B. The spread increases. C. The spread stays the same.

Answer 36

Correct Answer: B Explanation: Yield spread = Bond Yield - Benchmark Yield. If only the bond yield increases, the spread widens. Option A is incorrect as spread does not decrease. Option C only applies if both yields increase equally.

Question 37

Which component is NOT part of the benchmark yield? A. Real risk-free rate B. Expected inflation C. Credit risk premium

Answer 37

Correct Answer: C Explanation: Benchmark yield includes the real risk-free rate and expected inflation. Credit risk is part of the spread, not the benchmark.

Question 38

Which of the following most likely contributes to an increase in a bond's yield spread? A. Declining inflation expectations B. Increased credit risk C. Lower benchmark yield

Answer 38

Correct Answer: B Explanation: Yield spreads increase when credit or liquidity risks rise. Option A would typically reduce yields. Option C would affect benchmark yield, not spread directly.

Question 39

A bond has a yield of 5.85%. The interpolated swap rate is 3.65%. What is the I-spread? A. 220 basis points B. 250 basis points C. 200 basis points

Answer 39

Correct Answer: A Explanation: I-spread = 5.85% - 3.65% = 2.20% = 220 basis points Options B and C result from incorrect calculations.

Question 40

Why is interpolation used when calculating G-spreads? A. To estimate coupon payments. B. To match bond maturity to an exact benchmark yield. C. To account for changes in credit risk.

Answer 40

Correct Answer: B Explanation: When no government bond exists for a bond’s exact maturity, interpolation estimates the benchmark yield. Option A relates to cash flows. Option C affects the spread, not the benchmark.

Question 41

Which of the following would NOT cause an increase in a bond’s yield spread? A. Higher perceived credit risk B. Declining bond liquidity C. Lower inflation expectations

Answer 41

Correct Answer: C Explanation: Lower inflation expectations reduce yields generally but do not increase credit/liquidity risk. Options A and B both increase spread due to higher risk.

Question 42

Yield spreads help investors: A. Evaluate the risk-adjusted return of equity investments. B. Identify the inflation component of bond yields. C. Analyze credit and liquidity risk of bonds.

Answer 42

Correct Answer: C Explanation: Spreads isolate the bond-specific risks, especially credit and liquidity. Option A relates to equity, not bonds. Option B is part of the benchmark, not the spread.

Question 43

What does a rising yield spread imply if benchmark yields remain unchanged? A. Credit risk of the bond has improved. B. Microeconomic factors have worsened. C. Interest rates are increasing.

Answer 43

Correct Answer: B Explanation: Rising spreads with unchanged benchmarks indicate micro-level issues. Option A is the opposite. Option C would affect the benchmark as well.

Question 44

Which of the following is most likely to be used as the benchmark rate in euro-denominated bond markets? A. U.S. Treasury rates B. Interbank swap rates C. Japanese government bond yields

Answer 44

Correct Answer: B Explanation: Swap rates are the common benchmark in euro bond markets for calculating I-spreads. Option A is used for U.S. bonds. Option C is irrelevant for euro bonds.

Question 45

Which of the following best describes the zero-volatility spread (Z-spread)? A. The spread over the benchmark yield curve that accounts for bond price volatility. B. A constant spread added to each spot rate that equates the present value of a bond’s cash flows to its market price. C. The difference between a bond’s YTM and the YTM of a similar Treasury bond.

Answer 45

Correct Answer: B Explanation: Z-spread is calculated by adding a constant spread to each spot rate on the yield curve until the present value of a bond’s cash flows equals its market price. A is incorrect: Z-spread does not deal with volatility. C is incorrect: That describes the G-spread, not the Z-spread.

Question 46

The G-spread is defined as: A. The difference between the Z-spread and the OAS. B. The spread between the bond's yield-to-maturity and a government bond's YTM of similar maturity. C. The difference between spot rates and forward rates.

Answer 46

Correct Answer: B Explanation: The G-spread measures the risk premium investors demand above a risk-free government bond of the same maturity. A is incorrect: That refers to the option value. C is incorrect: That relates to term structure, not G-spread.

Question 47

Question 3: Which spread best accounts for the term structure of interest rates when valuing a bond? A. G-spread B. Z-spread C. I-spread

Answer 47

Correct Answer: B Explanation: Z-spread adjusts for the shape of the yield curve by using spot rates for each cash flow. A and C are both based on YTM, not the term structure (spot rates).

Question 48

An investor is valuing a callable bond. Which of the following spreads best isolates the risk associated with credit, liquidity, and taxation, excluding the embedded call option? A. Z-spread B. Option-adjusted spread (OAS) C. I-spread

Answer 48

Correct Answer: B Explanation: OAS removes the effect of the embedded option and focuses only on risks like credit and liquidity. A includes optionality. C is not adjusted for options and is based on swap rates.

Question 49

Which of the following statements is most accurate regarding OAS for a callable bond? A. OAS is greater than the bond’s Z-spread. B. OAS equals the Z-spread when the bond has no embedded options. C. OAS includes the option premium.

Answer 49

Correct Answer: B Explanation: OAS equals Z-spread only if the bond has no embedded options. A is incorrect: OAS is less than the Z-spread for callable bonds. C is incorrect: OAS excludes the option premium.

Question 50

If a callable bond has a Z-spread of 180 basis points and an OAS of 120 basis points, what is the value of the embedded call option? A. 60 basis points B. 300 basis points C. 120 basis points

Answer 50

Correct Answer: A Explanation: Option value = Z-spread – OAS = 180 – 120 = 60 bps B and C are miscalculations or misinterpret the concept.

Question 51

Why is the Z-spread typically higher than the OAS for a callable bond? A. It reflects only the term structure. B. It includes the option risk premium. C. It excludes the impact of liquidity risk.

Answer 51

Correct Answer: B Explanation: The Z-spread contains a component for the option risk, which OAS removes. A is true but not relevant to the difference. C is incorrect: Both Z and OAS include liquidity risk.

Question 52

The I-spread is calculated as the difference between a bond’s YTM and: A. The yield on an interest rate swap with the same maturity. B. The zero-volatility spread. C. The option-adjusted spread.

Answer 52

Correct Answer: A Explanation: I-spread = Bond’s YTM – Swap rate of same maturity. B and C are not used in I-spread calculation.

Question 53

Which of the following describes the method of calculating Z-spread? A. Add a fixed spread to each benchmark spot rate until PV = market price. B. Subtract the call option premium from the bond’s YTM. C. Average the yields of zero-coupon bonds of the same maturity.

Answer 53

Correct Answer: A Explanation: Z-spread is found by trial-and-error to equate the bond's PV with its price. B refers to deriving OAS. C is not a valid Z-spread method.

Question 54

Which spread is most appropriate when comparing corporate bonds to interest rate swaps? A. G-spread B. I-spread C. OAS

Answer 54

Correct Answer: B Explanation: I-spread compares bond yields to swap rates, a common practice in credit markets. G-spread compares to Treasuries. OAS is used for bonds with options.

Question 55

Which spread is most appropriate to use for pricing a bond with embedded options? A. Z-spread B. G-spread C. OAS

Answer 55

Correct Answer: C Explanation: OAS accounts for optionality, making it appropriate for option-embedded bonds. A includes the option component. B does not reflect either spot rates or options.

Question 56

Which of the following is TRUE regarding option-adjusted spread (OAS)? A. It overstates the credit risk of a callable bond. B. It is equal to the G-spread minus the Z-spread. C. It represents the spread after adjusting for the value of embedded options.

Answer 56

Correct Answer: C Explanation: OAS removes the value of the option from the Z-spread. A is false—the OAS isolates credit risk. B misrepresents the relationship.

Question 57

Which of the following measures requires trial-and-error computation? A. G-spread B. Z-spread C. I-spread

Answer 57

Correct Answer: B Explanation: Z-spread involves adding a spread to each spot rate until the present value matches market price. A and C are straightforward YTM comparisons and do not require iteration.

Question 58

Why is the OAS smaller than the Z-spread for a callable bond? A. Because it excludes credit risk. B. Because the call option reduces the investor’s yield. C. Because it includes an inflation premium.

Answer 58

Correct Answer: B Explanation: Callable bonds offer less yield due to call risk; OAS strips out the option value from the Z-spread. A is incorrect—OAS includes credit risk. C is irrelevant to spread analysis.

Question 59

Which of the following would result in a greater difference between Z-spread and OAS? A. A non-callable bond B. A deeply in-the-money callable bond C. A bond with no embedded options

Answer 59

Correct Answer: B Explanation: In-the-money callable bonds have high option values, increasing the spread between Z-spread and OAS. A and C have no options, so Z-spread = OAS.

Question 60

The primary reason to use OAS instead of Z-spread is to: A. Compare bonds with different maturities. B. Analyze bonds with embedded options. C. Adjust for liquidity premiums.

Answer 60

Correct Answer: B Explanation: OAS removes the effect of optionality, allowing for cleaner comparison of underlying risks. A and C are not the core focus of OAS.

Question 61

Which spread should an analyst use to assess the value of a bond relative to government rates when the bond has embedded options? A. G-spread B. OAS C. I-spread

Answer 61

Correct Answer: B Explanation: OAS adjusts for optionality, making it the correct measure. A and C are not adjusted for options.

Question 62

An analyst wants to isolate compensation for credit and liquidity risk in a callable bond. Which metric should be used? A. OAS B. Z-spread C. G-spread

Answer 62

Correct Answer: A Explanation: OAS excludes optionality, leaving credit and liquidity risk. B and C include the option value.

Question 63

What is the most likely result if the value of an embedded call option increases? A. OAS increases B. Z-spread remains unchanged C. OAS decreases

Answer 63

Correct Answer: C Explanation: As the option value increases, the difference between Z-spread and OAS widens—OAS becomes smaller. A is incorrect—the OAS falls. B is incorrect—Z-spread includes the option value.