1.A portfolio manager needs to hedge a USD 115 million liability. The portfolio manager is deciding between investing only in the 3%-coupon Treasury bond in the table below, or in a portfolio consisting of the shorter maturity 2%-coupon Treasury bond and the longer maturity 4.5%-coupon Treasury bonds.
Coupon Maturity Price   Yield Duration  Convexity
2.00% 6/31/2018 102 2.03%  4.5  35
3.00%  6/15/2023 101 3.29%  6  60
4.50%   6/14/2043 103 4.80% 14 40                                                                             

　　The convexity of the barbell portfolio that will match the duration and price of the bullet position will be closest to:
 
　　A. 60
 
　　B. 74
 
　　C. 83
 
　　D. 93
 
　　2.Which of the following deviations from normality leads to underestimating the distribution variance?
 
　　1.Higher probability of high returns.
 
　　2.Higher probability of mean returns.
 
　　3.The mean of the distribution is conditional on the economic environment.
 
　　4.The variance of the distribution is conditional on the economic environment.
 
　　A. III only.
 
　　B. I, II, and IV only.
 
　　C. III and IV only.
 
　　D. II only.
 
　　3.If the issuer of a bond is in default, the bond will be trading:
 
　　A. registered.
 
　　B. on accrual.
 
　　C. off the market.
 
　　D. flat.
 
　　Answer:
 
　　1.D
 
　　The barbell portfolio and the bullet portfolio may have the same duration but different convexity.
 
　　2.D
 
　　Statements I & III lead to overestimates of variance. Statement IV leads to over or under estimates of the variance.
 
　　3.D
 
　　If an issuer of a bond is in default (i.e., it has not been making periodic contractual coupon payments), the bond is traded without accrued interest and is said to trade flat.
 
　　A registered bond is a bond whose owner's name is recorded as a book entry on the books of the issuer or its transfer agent.


 
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