Fixed Income... The lurking giant

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This_is_not_easy

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So Fixed Income only had 3 practice assessments and as I found out this morning, seemingly only one section on the entire mock exam (maybe I missed that there was a 2nd cause there should’ve been but I only counted one).
I’m a first time L2er so I might not be in the know, but it seems very odd to me how little Fixed Income there was in all of the CFAI practice material…
What does this mean?!?!?!?
 
It means we don’t have enough practice assessments since the min weighting is 10% and it could be as high as 20%.
 
Most likely going to get tested on this as well for two reasons.
1) They increased the potential weightings
2) It’s all new material and the CFAI has been known to test the newer material they put in. I’d recommend Blue Boxes and EOC because there is nothing else you can do, honestly
 
Good topic. I think we are in store for 3 item sets on this. If you google past years exams in relation to new readings the last 5 years whenever there has been new readings they get tested, now we have an entirely reworked section that has increased weighting off last year that only had one item set on the exam. This is just as important as FRA and equity in my mind.
 
I think an important concept is how effective duration changes for callable and putable bonds in comparison to straight bonds as well as the behavior of convertible bonds when the conversion price is higher or lower than the current share price. Kind of random, but that’s something I think we will see on test day.
 
^ good thought. I’m hitting the FI BBs tomorrow. They’re prob the best vignette style examples we’ve got. TIA.
 
I actually don’t find Fixed Income all that tricky. Sometimes one-sided duration can be confusing, but aside from that, it’s really not that bad
 
Dr. Holmes from Schweser mentioned in the video lectures that he would guess they’re going to test on Structural and Reduced Form Models because they added them this year. Quite frankly, I don’t completely understand the two that well and I’m just going to try and memorize the assumptions, strengths, and weaknesses. Anyone think there is anything of note to remember regarding structural\reduced from models?
 
This_is_not_easy wrote:
Dr. Holmes from Schweser mentioned in the video lectures that he would guess they’re going to test on Structural and Reduced Form Models because they added them this year. Quite frankly, I don’t completely understand the two that well and I’m just going to try and memorize the assumptions, strengths, and weaknesses. Anyone think there is anything of note to remember regarding structural\reduced from models?
Click to expand...
No - Just what you mentioned.
 
… On another fixed income note, did anyone see in the CFAI mock fixed income section the question regarding the putable bond’s value in realtion to the straight bond’s value if the economists interest rate predicitons held and the straight bond value didn’t change?
So the economist predicted the yield curve will start to become upward sloping and he also predicted that yield volatility would decrease. Maybe I looked at it wrong, but I couldn’t figure out how to tell which action would effect the putable bond more.
The answer was that the putable bond increases in value. How do you know the upward sloping yield curve would effect the value of the putable bond more than the decline in interest rate volatility?
 
Reduced Form has reduced assumptions compared to the Structural Model. Thus, it’s typically an easier and more efficient model to use. The Reduced Form also includes the cyclical nature of the economy / company specific risk. The Structural Model has some really dumb assumptions too; like the RFR is static over the period and that the companies assets are traded in frinctionless markets.
All in all, reduced form is basically the better of the two. Oh, and I believe Reduced Form can use historical estimates vs the Structural Model using implicit estimates
 
^I used to think that for Structure and Reduced Form Models we would not be asked to calculate expected losses with intimidating formulas. But after working on FinQuiz mocks, I changed my mind and store these 2 formulas (not very hard to memorize) in my mind.
How about Convertible Bonds? Are you comfortable with questions on the topic?
 
This_is_not_easy wrote:
Dr. Holmes from Schweser mentioned in the video lectures that he would guess they’re going to test on Structural and Reduced Form Models because they added them this year. Quite frankly, I don’t completely understand the two that well and I’m just going to try and memorize the assumptions, strengths, and weaknesses. Anyone think there is anything of note to remember regarding structural\reduced from models?
Click to expand...
Structural models:assume all assets trade (if I recall), can only be calibrated (implicit estimation) (no historical estimation), equity is a call option on the firm’s assets
Reduced form models: don’t assume a balance sheet, can use implicit or historical estimation, only assumes that a zero coupon bond is traded, no assumption about the equity trading
Just a few of the many small points. Someone should correct any of those if something is wrong, I’m at the tail-end of the day…
 
TheLakeHouse wrote:
^I used to think that for Structure and Reduced Form Models we would not be asked to calculate expected losses with intimidating formulas. But after working on FinQuiz mocks, I changed my mind and store these 2 formulas (not very hard to memorize) in my mind.
How about Convertible Bonds? Are you comfortable with questions on the topic?
Click to expand...
Sort of, what’s the question?
 
TheLakeHouse wrote:
^I used to think that for Structure and Reduced Form Models we would not be asked to calculate expected losses with intimidating formulas. But after working on FinQuiz mocks, I changed my mind and store these 2 formulas (not very hard to memorize) in my mind.
How about Convertible Bonds? Are you comfortable with questions on the topic?
Click to expand...
I would not count on seeing the formulae solely because FinQuiz included it. If the LOS said calculate in reference to this formula, then I would be concerned.
 
This_is_not_easy wrote:
… On another fixed income note, did anyone see in the CFAI mock fixed income section the question regarding the putable bond’s value in realtion to the straight bond’s value if the economists interest rate predicitons held and the straight bond value didn’t change?
So the economist predicted the yield curve will start to become upward sloping and he also predicted that yield volatility would decrease. Maybe I looked at it wrong, but I couldn’t figure out how to tell which action would effect the putable bond more.
The answer was that the putable bond increases in value. How do you know the upward sloping yield curve would effect the value of the putable bond more than the decline in interest rate volatility?
Click to expand...
I think they asked about the interest rates separately from the volatility predictions. That’s how I interpreted it after rereading it a couple of times to be sure.
 
Mosstastic wrote:
TheLakeHouse wrote:
^I used to think that for Structure and Reduced Form Models we would not be asked to calculate expected losses with intimidating formulas. But after working on FinQuiz mocks, I changed my mind and store these 2 formulas (not very hard to memorize) in my mind.
How about Convertible Bonds? Are you comfortable with questions on the topic?
Click to expand...
Sort of, what’s the question?
Click to expand...
For a 2 year zero coupon bond issue:
Face Value: $895
Time to maturity : 1.5 years
default intensity: 0.03
Loss given default: 0.55
And they ask you what the maximum amount a bondholder would be willing to pay to remove risk of the bond.
If you know the formula, just plug the data in to get the answer. Otherwises, you have 33.33% of chance to hit the right one. And I would say it’s a random guess, ..
@tickersu: LOS h: calculate and intepret the present value of the expected loss on a bond over a given time horizon :)). Well, I memorize those 2 formula ..just in case…
 
This_is_not_easy wrote:
Dr. Holmes from Schweser mentioned in the video lectures that he would guess they’re going to test on Structural and Reduced Form Models because they added them this year. Quite frankly, I don’t completely understand the two that well and I’m just going to try and memorize the assumptions, strengths, and weaknesses. Anyone think there is anything of note to remember regarding structural\reduced from models?
Click to expand...
Thats untrue, those concepts were part of the credit reading last year so it’s not new. I’d also caution you from listening to what Holmes thinks will be on the exam, I listened to him last year (huge mistake on my part) and here I am writing again this year. Nice guy but he needs to stick to teaching the material and less opinions on what you should focus on because he is way off
 
TheLakeHouse wrote:
Mosstastic wrote:
TheLakeHouse wrote:
^I used to think that for Structure and Reduced Form Models we would not be asked to calculate expected losses with intimidating formulas. But after working on FinQuiz mocks, I changed my mind and store these 2 formulas (not very hard to memorize) in my mind.
How about Convertible Bonds? Are you comfortable with questions on the topic?
Click to expand...
Sort of, what’s the question?
Click to expand...
For a 2 year zero coupon bond issue:
Face Value: $895
Time to maturity : 1.5 years
default intensity: 0.03
Loss given default: 0.55
And they ask you what the maximum amount a bondholder would be willing to pay to remove risk of the bond.
If you know the formula, just plug the data in to get the answer. Otherwises, you have 33.33% of chance to hit the right one. And I would say it’s a random guess, ..
@tickersu: LOS h: calculate and intepret the present value of the expected loss on a bond over a given time horizon :)). Well, I memorize those 2 formula ..just in case…
Click to expand...
For the LOS– I think they won’t have us using the formulas that look similar to Black and Scholes formulas…the EOC has a few examples where you calculate PV expected loss from a table they provide. That’s where I’m putting my money.
Edit: Also, if you follow the LOSs in order of the chapter, this LOS aligns with section 6.3, where they use the simple way of calculating PV expected loss
 
tickersu wrote:
This_is_not_easy wrote:
… On another fixed income note, did anyone see in the CFAI mock fixed income section the question regarding the putable bond’s value in realtion to the straight bond’s value if the economists interest rate predicitons held and the straight bond value didn’t change?
So the economist predicted the yield curve will start to become upward sloping and he also predicted that yield volatility would decrease. Maybe I looked at it wrong, but I couldn’t figure out how to tell which action would effect the putable bond more.
The answer was that the putable bond increases in value. How do you know the upward sloping yield curve would effect the value of the putable bond more than the decline in interest rate volatility?
Click to expand...
I think they asked about the interest rates separately from the volatility predictions. That’s how I interpreted it after rereading it a couple of times to be sure.
Click to expand...
Thanks for looking. I re-examined it and I think you’re correct. It wasn’t very explicit in the question IMO but they don’t mention the volatility in the question.
 
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