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April 2015 q4 - anomaly switching

D

dimitris13

Member
Hi there,
A few points that i dont get :
In q:
i) at bullet 2 mentions” in particular it should be noted that a switch from 4.75 to 3.75 bond results an increase in yield if the switch is ultimately htm. “ why is that? A quick numerical example ? Can we deduce from the info that the 3.75 has higher ytm so the yield difference will be larger than the 0.13?
ii ) what the “little change in maturity means”

iii) which one is the underpriced here? Why the underpriced to be received in a trs? Is it bc it is larger? And if so why is this?
finally what the -ve exposure means?

thanks
 
Additionally in i). Why we write/care about the movements being reversed?
 
Hi. The yield pick up is not anything complex. If you look to the right hand side it gives the yield of both bonds. 2.46% and 2.33%. You are switching into the higher yielding. I cant see any reference in the examiners report to reversing the switch in part (i). It is a suggested consideration in part (ii) - clearly there would be costs if it was reversed which is a consideration.
The little change in maturity refers to the small change from March to September maturity.
In part (iii) the examiner does not ask you to determine which of the two bonds above is over or underpriced. So this is not part of the answer. Negative exposure means having exposure to the asset reducing in price rather than increasing.
 
"I cant see any reference in the examiners report to reversing the switch in part (i)"
it is mentioned in the asset/revision notes answers.

in general 2.46-2.33 =0,13. A yield pick up (if we hold it to maturity) is it expected to widen or not (assuming the only difference is the Cpn %)?
 
dimitris13 said:
"I cant see any reference in the examiners report to reversing the switch in part (i)"
it is mentioned in the asset/revision notes answers.

in general 2.46-2.33 =0,13. A yield pick up (if we hold it to maturity) is it expected to widen or not (assuming the only difference is the Cpn %)?
Click to expand...

The revision booklets probably added it as it was considered to be an idea that is likely to score marks if a similar question was asked again. If the switch was reversed (as the reading suggests that many are) the costs of this would be a consideration.
In terms of the switch yield pick up widening or not, it is impossible to say given the information in the question. The yield pick up is not due to the coupon as the higher coupon bond in the question has the lowest GRY.
 
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