Q1 Statement: “If the bond market is turning, HSU Asset Management would be switching his $20 million

position of 7 year single-A nonbank financials bonds callable in two years to 15-year US Treasury Coupon
bonds“ according to DC, Chief Investment Officer (CIO) of HSU.

Currently, DC thinks a further downturn in bond market is unlikely. So, in anticipation of a rebound, HSU starts to
BUY 15-year US Treasury Bonds and SELL his Single A rated nonbank financial bonds. This has increased the HSU
duration of its $200 million bond portfolio from 4.3 to 7.5, substantially higher than the benchmark duration of 5.5
because DC thinks the bond will start to rally.

DC said he does not like single-A nonbank financials because these bonds are at lower yield spreads (about 50-100
basis points) below the benchmark yield of US Treasuries yield.”

From the description of the above situation, explain the following:

(i) What is DC’s view on the interest rate?

(ii) What is the purpose of switching from 7 year single-A nonbank financials bonds to 15- year US Treasury Bonds?

(iii) Can you explain three purposes of selling 7 year single-A nonbank financials bonds callable in two years?
Q2 On June 1, 2019, a bond portfolio manager is evaluating the following data concerning the following 3 bonds held in
his portfolio.
Bond Rating Coupon Maturity Call Price (Date) Market Price YTM Modified Duration Change in Market Price
X A 0% 8/14/2024 Noncall 59.44 10.25% 5.2 years +5.1%
Y A 14% 3/30/2028 Noncall 116.60 11.00% 5.2 years +5.5%
Z A 10.25% 7/15/2027 100 (6/1/2020) 98.63 10.50% 5.2 years +2.4%

He observed that all 3 bonds have the same modified duration and thus are expected to rise in price by 5.2% for a 1%
decline in interest rates. However, the data shows that a different change in price occurs for each bond.

(i) Discuss 2 reasons for the discrepancy between the expectations and the actual change in market price for the bonds.
Q3 China Air Ltd has issued a Convertible Bond of US$100,000,000 with the following conditions:

Price at Issue 100

Annual Coupon 4%

Maturity 5 year (final payment at par)

Conversion At any time, a bond with a US$6000 nominal (or face) value can be
exchanged against one China Air share.

On issue date, a China Air 5 year straight bond with a 4.25% coupon was quoted at 83.00 (which gives a yield to maturity
of 6.75%). The share price of China Air at issue was US$5660.

An investor who is considering buying the China Air Convertible Bond, has a very bullish view on China Air share price
over the next 5 years seeing an upside of at least 30% from share price on issue date. Analyse using conversion premium
and minimum target share price to determine if the investor should buy the China Air Convertible Bond?
Q4 An investor bought an US Treasury Bond that pays annual 5% coupon with a maturity of 4 years. Three months (or 90
days) later, the investor is contemplating to sell the bond at an annual 5.75% yield to maturity. In the market, the US
Treasury bond dealer is making a bid at around 95.01% and the investor seems to be willingly to sell it around this price.
Should he sell his bonds at the market bid price?
Note: The US Treasury Bond follows a Act/360 convention
Q5 The “bid” and “ask” yields for a 100-day US Treasury Bill were quoted by a bond dealer as 5.95% and 5.87%,
respectively. The face value of this US Treasury Bill is $100,000. Shouldn’t the “bid yield” be less than the “ask yield”,
because the “bid yield” indicates how much the dealer is willing to pay and the “ask yield” is what the dealer is willing to
sell the Treasury Bill for? Please explain your view on this with an illustration of calculation.
Q6 US listed company, ABC, is considering raising debt financing for 5 years in US dollar for an acquisition of a tech
firm that is expected to add more business diversity to ABC and will increase overall earnings by 50%. Recently, ABC
had a bad fall in earnings on the last annual reporting and the solvency ratios are deteriorating. However, ABC’s credit
rating has not been downgraded but the credit rating agencies (Moody & S&P) have already put a “negative” view on
ABC’s outlook. Therefore, the success of this acquisition is crucial to ABC.
The interest rate environment (yield curve) is currently mildly upwards at a low interest rate across the whole curve due to
government stimulus measure mostly through monetary policy. With the increasing number of countries receiving
vaccines, the hope of global normality is within sight and economic recovery would be expected in early next year. The
interest rate market will then be expected to rise to resume normal economic level. Equity investors are starting to focus
investment on potential attractive company earnings and sentiment is very positive.

ABC’s Chief Financial Officer (CFO) is contemplating the following options of issuance:
(a) Callable Bond
(b) Fixed Coupon Bond
(c) Fixed Coupon Bond cum equity warrants
(d) Convertible Bond

The CFO seeks an investment banking advisor for issuance recommendation for a second opinion. Discuss each of the
financing options in the light of investors’ demand and issuer’s cost perspective, explain what would be the possible
choices of issuance that the advisor would be advising?
Q7 An investor has the following bond portfolio:

Semi Annual Coupon Maturity Semi Annual Yield

Face Value (%pa) (Yrs) (%pa)
Bond A US$2,000,000 10 6 7.4
Bond B US$4,500,000 3 5 6.6
Bond C US$3,500,000 6.5 1 8
Bond D US$7,000,000 0 12 5
US$17,000,000

(i) What is the portfolio Macaulay duration?

(ii) The interest rate outlook expects to increase so the investor decides to reduce the portfolio to a target Macaulay
duration of 3. The investor decides to keep the weighting on Bond C and Bond A, how much Bond B and Bond D do the
investor need to “change” in order to meet the target?
(iii) Instead of (ii), the investor has a choice to keep all the bond portfolio and only to replace Bond A by one of the
following three bonds issued by the same issuer to decrease portfolio duration.

Annual
Credit Semi Annual Coupon Maturity Semi Annual Yield Maculary
Rating (%pa) (Yrs) (%pa) Duration
Bond X AA 10 6 4.5 3
Bond Y AAA 10 6 4.5 3
Bond Z CCC 10 6 4.5 3

Explain which of these 3 bonds will the investor choose to have the best protective impact on interest rate increase?
Q8 The diagram below shows the impact of Credit Ratings on Bond Yields

A bond investor has a portfolio of AA, A, BBB and BB corporate bonds from the same sector. The investor expects a
declining yield spread between “AA” and “A” rating, while a widening yield between “AA” and “BB” rating, though the
yields for “A” rated bonds remain constant. In anticipation of such move, the investor will adjust the weighting of these
bonds. Which would he “overweight”, “underweight” and “neutral” based the expectation?
Q9 HSU just issued US$200 million 10 year bond at PAR with an annual coupon of 2% attached with a 3 year warrants
on HSU shares. Each bond has a US$10,000 denomination and has 500 detachable warrants. 1 warrant allows bondholder
to purchase one HSU share at an exercise price of US52. Currently the HSU share is quoted at US$40 and the Yield to
Maturity (YTM) of a similar fixed coupon bond issued by HSU is 4%.

(a) If the market has a standard that if a warrant has a premium greater than 20%, the warrant is then expensive. Given the
issuance terms, would you recommend investors to buy this issue? Hint: Calculate the $ value per warrant to evaluation
the warrant premium in %.

(b) At the same time as (a), HSU also issued a Convertible Bond (CB) with a zero coupon with a Conversion Price that
gives the Conversion Premium the same Warrant Premium as Bond cum Warrant in (a). If investors have an extremely
bullish view on HSU over the next 10 years, what would you recommend to investors between this CB and the “Bond
with Warrants” described in (a). Explain the rationale between your recommendation.

(c) HSU is considered issuing a callable fixed coupon bond. The issuing terms are 6 year maturity with 8% annual coupon
callable at year 3 and every year thereafter at a Call Price of $110. The issue price is at PAR with the yield to maturity
(YTM) is 7%. A similar 6 year government bond yields 4%. If the call option part of this Callable Bond is valued at 7.
The market has a comparable non callable fixed coupon bond by another issuer (EAF) that has a 3% YTM. Can you
review the attractiveness of HSU callable bond’s credit (or yield) spread comparing with the EAF bond? Hint: Analyse the
Call Adjusted Yield spread (CAS) to assess.
Q10 A bond portfolio manager, John, holds $10 million par value of Bond ABC and it is trading at 75% with a modified
duration of 6.5. John is considering swapping out of Bond ABC and into Bond XYZ so that the Dollar Duration ($D) is the
same. The price of Bond XYZ is 88% and has a modified duration of 4.

(a) How much in market value of Bond XYZ should be purchased?

(b) Answer the each of the following questions (i) to (v) about selecting bonds to maximize the return for your client
portfolios in terms of all these characteristics:
- Duration
- Coupon
- Maturity
- Credit rating

(i) What would you look for in a bond chosen for your client who can take high risk?

(ii) What would you look for in a bond chosen for your client who can only take low risk?

(iii) If you believe that interest rates will decline sharply in the future, what bond characteristics would you search for?

(iv) If you believe that interest rates will rise sharply in the future, what bond characteristics would you search for?
Q11 Given these three default-free US Treasury Bonds, repaid at 100% with the following characteristics:
Annual Coupon Maturity Price YTM

Bond A 5% 1 year 100 5%

Bond B 6% 2 years 101.48 5.2%
Bond C 8% 3 years 106.74 5.5%

On the same date, a new default-free US Treasury bond (bond D), with an annual coupon of 9% and repaid at parity
in three years, is worth 110%.

Show that this situation reveals a price disequilibrium and that you can make an arbitrage using bonds A, B and C.
Present all your calculations. (Hint: consider cash flow matching for arbitrage)
Q12
(A) A bond has a 30-year maturity with an 8% annual coupon rate offering at an annual yield to maturity
(YTM) of 8%. Also, you are told that the modified duration (Dmod) of the bond, at its initial yield, is
11.26, and that the bond’s convexity is 212.4. The bond yield has just increased from 8% to 10%.
(i) Estimate how much the bond price would decline by applying the duration estimate.
(ii) Calculate the actual bond price and how much will it actually fall?
(iii) Can you explain differences with the result in item (b) and (a)?

(B) An investor is investing in a bond with a 6-year maturity with 6% annual coupon at PAR. The
investor plans to invest the bond for 4 years before selling it off. Assume further that in the following
years interest rates follow a downtrend, so that the coupon received in year 1 is invested for three years at
4.5%; the coupon received in year 2 is reinvested for two years at 3%, and the coupon received in year 3
is reinvested for 1 year at 2%. 4 years later, the YTM of the bond is expected to increase to 8%. What’s
the realized compound yield (RCY) in year 4.
Q13
(A) Historically, a yield curve such as YC1 below depicts a situation that will change over time to a yield curve such as
YC2. What should investors consider doing when a yield curve looks like YC1?

YC1
% Yield
YC2

Years to Maturity

(B) A fixed-income portfolio manager is unwilling to realize a rate of return of less than 4% annually over a 8 year
investment period on a portfolio currently valued at $1 million. 5 years later, the interest rate is 12%. What is the
trigger point of the portfolio at this time, that is, how low can the value of the portfolio fall before the manager will
be forced to immunize to be assured of achieving the minimum acceptable return?

(C) Find the quantities of 1-year and 30-year US Treasury zero-coupon bonds to purchase in order to immunize
against the target portfolio with a Market Value of $374.65 and modified duration of 5.42 years. The zero-coupon
bonds have a face value of $100 and a yield of 5%.
Q14
(A) The yield to maturity (YTM) on 1 year zero coupon bonds is 5% and the yield to maturity on 2 year zero coupon
bonds is 6%. The yield to maturity on 2 year coupon bonds with coupon rates of 12% (paid annually) is 5.8%.
(i) Demonstrate if there is an arbitrage opportunity available to a trader?
(ii) If (i) exists, what is the profit on the arbitrage activity?