fixed income test 3 (Answered) Complete Solution

fixed income test 3 (Answered) Complete Solution delta first-order sensitivity to the price of the underlying asset; positive for calls and increase with moneyness, negative for puts and decrease with moneyness gamma measures how delta changes as spot price increases theta measures time decay of an options value; always negative for calls, usually negative for puts vega sensitivity of an options price to changes in volatility of the underlying asset rho sensitivity of an option price to changes in the risk free rate (r); positive for calls, negative for puts bullet bond bond in which the principal repayment is made entirely at maturity plain vanilla bond bond that makes periodic, fixed coupon payments during the bond's life and a lump-sum payment of principal at maturity fully amortized bond bond where principal is repaid gradually by maturity; similar to sinking fund credit risk risk of default; non-agency RMBS and credit card RBS have this interest rate risk aka price fluctuation risk; changes in rate could affect value of bond liquidity risk a less severe form of credit risk reinvestment rate risk risk that CFs will have to be reinvested at a lower rate contraction risk risk that prepayment speed will increase; happens when interest rates decrease and people refinance homes extension risk risk that prepayment speed will decrease; happens when interest rates increase and people stay in their homes balloon risk risk that the borrower will not be able to make lump sum payment at maturity prepayment risk the risk that mortgages underlying a agency-backed security/pass-through will be paid off sooner than expected due to a drop in interest rates local expectations theory theory that bond maturity does not influence returns for short holding periods liquidity preference theory