8006 Exam Dumps : Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition

Explanation:

If the spot rate is 1.1010 and the forward is 1.1040, the swap rate is 30 "points" (= 1.1040 - 1.1010). The annualized swap premium is the swap premium divided by the spot rate, and therefore =0.0030/1.1010 =0.27%, or 27 basis points.

Statement I is not correct because the 4% bond with the same modified duration as the zero coupon bond will have a maturity much later in the future than the zero coupon, and the final repayment coming much later will cause its convexity to be greater than the equivalent duration zero coupon bond.

Statement II is not correct as the convexity of a bond increases not in a linear fashion but in proportion to the square root of time as the maturity of the bond is increased.

Statement III is not correct as mortgage based bonds bring negative convexity even in the case of long positions,

Statement IV is not correct as the duration of a zero coupon bond maturing in 10 years has a modified duration greater than that of a coupon bearing bond of the same maturity, which means its convexity is higher and not lower (note this is different from statement I where the modified durations were identical. Here, the maturity is identical which has different implications.)

Therefore none of the statements is correct and Choice 'd' is the correct answer.

Backwardation is said to occur when futures prices are lower than the current spot prices. This would happen only when carrying costs are negative. Carrying costs are equal to interest, plus storage costs and less any 'convenience yield'. The existence of large convenience yields may explain backwardation in commodity futures prices. Therefore Choice 'd' is the correct answer.

Contango is the 'normal' market situation where forward prices are higher than spot prices. Storage costs explain contango, not backwardation. Risk free rates, or the cost of funding for the futures position, are always positive and do not explain backwardation.