CFA CFA Level 3 Rioja – Mock B Q4 – Structural Analysis

Rioja – Mock B Q4 – Structural Analysis

  • This topic has 13 replies, 4 voices, and was last updated Oct-17 by RaviVooda.
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    • Alta12
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      @ravivooda @vincentt

      Priorat states: Structural analysis of corporate bonds is an important part of active management. Credit bullets in conjunction with long end treasury structures are used in a barbell strategy. Callable bonds provide a spread premium that can be valuable to an investor during periods of high interest rate volatility. Put structures will provide investors with some protection in the event that interest rate rise sharply but not if the issuer has an unexpected credit event.

      Q: Priorat is most likely correct with regard to which structural trade:

      A) Putables
      B) Bullets
      C) Callables

      Answer is B) Bullets. I choose putables. Why is putables wrong?

    • vincentt
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      @alta12 i picked putable as well since callable is definitely incorrect and i’ve no clue about B. Would like to know bout this too.

    • Sophie Macon
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      @vincentt @Alta12‌ putable bond is wrong because even if the issuer experienced some credit event, it does provide protection in the sense that the ranking of putable bond would be higher (in the peking order of payout) than standard bonds. So if the issuer could only make half the payout, the priority would be to putable bond holders first.

    • Sophie Macon
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      Barbell strategy portfolio can have either very short or very long maturities for bonds. In this case credit bullets (i suppose it’s another name for bullet loans or bonds) can have short or long term maturities, which makes it ‘most correct’. I think the term bullet may have confused you all as the bullet strategy is opposite of barbell strategy.

    • RaviVooda
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      @alta12,@vincentt, why is callables wrong?

    • vincentt
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      @RaviVooda‌ I think what @Sophie‌ said was in this “Put structures will provide investors with some protection in the event that interest rate rise sharply but not if the issuer has an unexpected credit event.” statement the bold part is incorrect as during an unexpected credit event as a put bondholder you have a higher priority over a straight bond.

      Not that I’ve read that anywhere, but I’m just gonna accept it as it is (too many other stuff to cover lol) but maybe @sophie can explain further?

    • RaviVooda
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      @vincentt , I was referring to option c, callables. I could not figure out why it is wrong. Can you please explain why it is wrong.

      As regards to puttables, I agree with @Sophie. Because put bondholders take less interest coupon to buy the right of selling, they stand first in the queue in case of any unfortunate event. So the statement is wrong. In our text I don’t remember reading this. However one point our text says is that, analysts do not consider credit risk of company while valuing puttable bonds

    • vincentt
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      @RaviVooda‌ callable bond is definitely incorrect.

      Callable Bond Price = Straight Bond – Call Option Price

      High volatility => Higher Call Option Price => reduced callable bond price

      Therefore, for callable bondholders it’s a bad thing.

    • RaviVooda
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      @vincentt, thanks. I missed the word “volatility” and some how read it as “interest rates” only. These kind of mistakes are scary. Should pray that I shouldn’t do such mistakes on exam day

    • vincentt
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      @RaviVooda‌ you’ll be fine! Just stay calm.

      I made many mistakes as well, mostly due to tiredness.

    • Sophie Macon
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      @RaviVooda‌ I’m gonna clarify @Vincentt’s statement.

      I suspect the reason why you’re confused about callable bond is that one can forget who owns the call option. Callable bonds means the ISSUER has the right to redeem the bonds prior to maturity, i.e. the bondholder has effectively a call option, usually receiving a higher bond coupon to reflect this premium.

      So yes, they have a premium (in yield), but during periods of higher volatility, as per @vincentt’s equation above, that call option is more valuable, reducing the callable bond price, i.e. less valuable to investors during periods of high interest rate volatility.

      Hope this helps!

    • RaviVooda
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      @Sophie thank you. However I understood in a very wrong way. I was thinking since the interest rates are high, the callable bond would outperform. I did not read the word “volatility”

    • Alta12
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      @ravivooda @vincentt @Sophie

      I don’t believe credit bullet was specifically covered in our notes. Are these corporate bonds with maturity of 5 years?

    • RaviVooda
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      @alta12 credit bullets imply corporate bonds with maturity of few years.

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