Question #3
Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers
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Question
The effective convexity of a bond is most likely to be negative if the bond is:
Answer Choices:
A. callable
B. putable
C. option-free. Explanation The effective convexity of a callable bond be negative (meaning that the upside for the callable bond is smaller than the downside) when the call option is near the money. Option-free bonds exhibit positive convexity, meaning that the price rises more when interest rates fall than the bond price declines when interest rates rise by the same amount. The convexity of putable bonds is always positive. (Module 27.6, LOS 27.l) Bill Woods, CFA, is a portfolio manager for Matrix Securities Fund, a closed-end bond fund that invests in U.S. Treasuries, mortgage-backed securities (MBS), asset-backed securities (ABS), and MBS derivatives. The fund has assets of approximately $400 million, has a current stock price of $14.50 and a net asset value (NAV) of $16.00. Woods is a member of a four person investment team that is responsible for all aspects of managing the portfolio, including interest rate forecasting, performing basic financial analysis and valuation of the portfolio, and selecting appropriate investments for Matrix. His expertise is in the analysis and valuation of MBS and ABS. The fund pays a $0.12 monthly dividend that is paid from current income. The basic operating strategy of Matrix is to leverage its capital by investing in fixed income securities, and then financing those assets through repurchase agreements. Matrix then earns the spread
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