INV2601: INVESTMENTS AN INTRODUCTION
ASSIGNMENT 02 SOLUTIONS
SEMESTER 1 2023
QUESTION 1
Which bond risk exposure entails the possibility that the issuer will fail to meet their obligations
regarding the timely payment of coupons and principal?
a. credit spread risk
b. default risk
c. downgrade risk
d. interest risk
Credit risk comprises default risk, credit spread risk and downgrade risk.
Default risk - is defined as the possibility that the issuer will fail to meet its obligations regarding
the payments of coupons and the eventual principal in a timely manner.
Credit spread risk - A credit spread is the difference in the yield between different bonds due
to their different credit quality. The credit spread reflects the additional net yield an investor
can earn from a less credit risk. Reflects the extra compensation investors receive from
bearing credit risk. Credit spread risk is measured by the size of the yield differential (risk
premium or spread) of a particular bond above a default-free government bond.
Downgrade risk - is the risk that a bond’s price will decline due to a downgrade in its credit
rating. Downgrade risk arises from the deteriorating financial condition of a company and is a
risk every bond faces to a certain extent.
QUESTION 2
A zero-coupon bond has a par value of R1 000 with a maturity of 20 years and a yield to
maturity of 8%, compounded semi-annually. What is the present value of the bond?
a. R208.29
b. R214.55
c. R456.39
d. R1 000.00
, N = 40 (20x 2)
I/YR = 4 (8/4)
PMT = 0 FV =1000
CPT PV = 208.29
QUESTION 3
A/An ... yield curve is one in which the yields on intermediate-term issues are above the yields
on short-term issues and the rates on long-term issues decline to levels below those for the
short-term issues before levelling out.
a. upward-sloping
b. downward-sloping
c. flat
d. humped
The correct answer is d. humped.
In a humped yield curve, the yields on intermediate-term issues are above the yields on short-
term issues, but the rates on long-term issues decline to levels below those for the short-term
issues before levelling out. This results in a curve that has a hump or a peak in the middle.
In contrast, an upward-sloping yield curve (option a) is one in which the yields on long-term
issues are higher than the yields on short-term issues.
A downward-sloping yield curve (option b) is one in which the yields on short-term issues are
higher than the yields on long-term issues. A flat yield curve (option c) is one in which the
yields on short-term and long-term issues are roughly the same.
ASSIGNMENT 02 SOLUTIONS
SEMESTER 1 2023
QUESTION 1
Which bond risk exposure entails the possibility that the issuer will fail to meet their obligations
regarding the timely payment of coupons and principal?
a. credit spread risk
b. default risk
c. downgrade risk
d. interest risk
Credit risk comprises default risk, credit spread risk and downgrade risk.
Default risk - is defined as the possibility that the issuer will fail to meet its obligations regarding
the payments of coupons and the eventual principal in a timely manner.
Credit spread risk - A credit spread is the difference in the yield between different bonds due
to their different credit quality. The credit spread reflects the additional net yield an investor
can earn from a less credit risk. Reflects the extra compensation investors receive from
bearing credit risk. Credit spread risk is measured by the size of the yield differential (risk
premium or spread) of a particular bond above a default-free government bond.
Downgrade risk - is the risk that a bond’s price will decline due to a downgrade in its credit
rating. Downgrade risk arises from the deteriorating financial condition of a company and is a
risk every bond faces to a certain extent.
QUESTION 2
A zero-coupon bond has a par value of R1 000 with a maturity of 20 years and a yield to
maturity of 8%, compounded semi-annually. What is the present value of the bond?
a. R208.29
b. R214.55
c. R456.39
d. R1 000.00
, N = 40 (20x 2)
I/YR = 4 (8/4)
PMT = 0 FV =1000
CPT PV = 208.29
QUESTION 3
A/An ... yield curve is one in which the yields on intermediate-term issues are above the yields
on short-term issues and the rates on long-term issues decline to levels below those for the
short-term issues before levelling out.
a. upward-sloping
b. downward-sloping
c. flat
d. humped
The correct answer is d. humped.
In a humped yield curve, the yields on intermediate-term issues are above the yields on short-
term issues, but the rates on long-term issues decline to levels below those for the short-term
issues before levelling out. This results in a curve that has a hump or a peak in the middle.
In contrast, an upward-sloping yield curve (option a) is one in which the yields on long-term
issues are higher than the yields on short-term issues.
A downward-sloping yield curve (option b) is one in which the yields on short-term issues are
higher than the yields on long-term issues. A flat yield curve (option c) is one in which the
yields on short-term and long-term issues are roughly the same.
