PART A – Please answer ALL questions from Part A
Question 1:
A. Adam is an asset manager. He is underweight US bonds because he believes that inflation pressures and rising rates will continue hurting bond markets over the next few months and US bonds will continue to trade lower in price. However, he is worried that if inflation readings come in lower than expected over the next months, then central banks will not raise rates as aggressively as bond markets have been pricing it and we may witness an increase in demand for US bonds.
What kind of strategy would you recommend for him to partially hedge his portfolio and why? What are the advantages and disadvantages of the recommended strategy? (5 points)
B. Adam thinks that any rally (bond prices going up) will be limited in magnitude and rather short lived. He is also concerned that implied volatility is very high, so he would like to minimize his vega exposure.
Outline three (3) different strategies that Adam could follow and explain the advantages and disadvantages of each strategy. (15 points) [500 words limit] (Total 20 points)
Question 2:
Discuss the main types of active fixed income portfolio management strategies. Under what circumstances would an active strategy be the optimal solution for a bond portfolio? [500 words limit] (20 points)
PART B - Please answer any FOUR (4) questions from this part
Question 3:
Outline the main risks an investor faces when buying individual bonds and discuss which type of bonds are more exposed to each type of risk. [500 words limit] (15 points)
Question 4:
Compare convertible bonds with warrants. [500 words limit] (15 points)
Question 5:
Briefly explain LIBOR and OIS rates and then comment on the following: “2008 crisis showed us that LIBOR has its limitations. Please explain what went wrong with using LIBOR during the 2008 crisis and explain in detail why you think that using OIS rates instead of LIBOR rates would be more efficient and accurate?” [500 words limit] (15 points)
Question 6:
A. Explain the different tranches of CDOs and the distribution rules of Income and Principal Cash Flows on CDOs. Discuss which tranche offers maximum protection to the investment holder. (10 points)
B. Using the answer to part A, elaborate further in which way CDOs can create a liquidity squeeze in the financial markets. (5 points) [500 words limit]
Question 7:
Define Exchange Traded Funds (ETFs) and discuss their main advantages. Compare ETFs with closed-ended funds such as investment trusts and openended funds such as mutual funds. [500 words limit] (15 points)
Question 8:
Georgia is the CFO for a big investment firm. During the last board meeting, there were concerns about the prices of USD and GBP bonds over the next year. The board believes that there will not be strong demand for any government debt as the world is recovering from COVID-19 and inflation continues to grow at the fastest pace for decades. Both FED and Bank of England raised rates recently and market participants believe that there will be more hikes in the future. US and GBP bonds have been selling off over the last quarter and Georgia is worried that this will continue at least until the end of this year. However, there is always the risk of any new COVID-19 variant may cause a new lockdown during winter 2022 that may cause central banks to stop raising rates and increase investors demand for “safe haven” assets like US and GBP bonds. Their view is that financial markets underestimate the downside of USD bonds over the next two quarters and that they underestimate the upside of the USD bonds over the next year. Also, the board believes that the financial markets underestimate the downside of GBP bonds over the following year. Georgia is trying to find ways to express the board’s view by trading financial instruments.
Lastly, the board wants to make sure that any hit on demand for government debt in general is not going to affect their business dramatically.
Suggest four trades that Georgia should do to express board’s views and any concerns she may have when she chooses which product to trade? [500 words limit] (15 points)
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