FIN 4243 Final

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20 Terms
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Value is equal to:
the sum of the future expected cash flows discounted at the appropriate rate of return
all else equal, a decrease in an asset's discount rate (its expected rate of return) leads to ______ in its value
an increase
Suppose an asset's cash flows become higher than currently expected. All else equal, this change would lead to ______ in the asset's value
an increase
Relative to that of a non-callable bond, the yield to maturity of callable bonds will be ________
Higher because the callable bond has a lower price than the non-callable bond with otherwise equivalent features
Suppose the interest rate volatility is lower than anticipated, which of the following statements is true?
The price would increase because lower volatility means that future cash flows are more certain
The duration of a callable bond is ________ that of an otherwise comparable non-callable bond because _____________.
Less than; callable bonds have limited upside price potential since the issuing firm will exercise the call option if the market price exceeds the call price
Callable bonds
bond with an embedded call option that allows the issuer to call the bond back at prespecified times at prespecified prices
If a bond gets called you are mainly exposed to ______ risk
callable bonds value are ____ than noncallable bonds
why would an investor buy a callable bond?
1. callable bonds are cheaper 2. if yields increase then the investor makes a higher return (because bought a cheaper price)
call option value is increased with volatility
more uncertainty, more value, higher the risk, higher the reward
if interest rate volatility goes down, then prices will go _____
up because certainty goes up
Mortgage backed securities
an example of an "asset-backed security", payments are based on the mortgage payments of commercial/ residential real estate owners
time tranches allocate principal and prepayments _______
sequentially by seniority
time tranches allocate default proportionally among all tranches
credit tranches allocate principal and prepayments _____
credit tranches allocate default to the most _____ tranche and move ______
junior, upward
What happens to the duration of the MBS as the rate of prepayment increases?
duration decreases because you get more cash flows sooner
If you are a pension fund and are most worried about the duration of your investment contracting, in which time tranche should you invest?
the most junior tranche, because it is the least likely to have duration shortened with prepayment since they get paid last
People buy credit/ default tranches because they are cheaper, have a higher risk, which in turn have a higher yield