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NEW QUESTION: 3
Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President ai Langsford Investments, has asked for assistance with the evaluation of mortgage-backed and collateralized mortgage obligation (CMO) derivative securities for potential inclusion in several client portfolios. Langsford Investments mainly deals with equity investments and REITs, but the company recently purchased a small firm that invests mainly in fixed-income securities.
Lullum has done some research on the appropriate spread measures and option valuation models for fixed-income securities and wants to clarify some points. He wants to know if the following statements are correct:
Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.
Statement 2: Callable corporate bonds and mortgage-backed securities should be measured using the option-added spread.
Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.
While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfolio manager for Langsford, is attempting to purchase bonds that may also provide her with equity exposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 years to maturity. The bonds are convertible into 10 common shares for each $ 1,000 of par (face) value. The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimates that the stock will increase in value to $70 within the next two years. The stock's annual dividend is $0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.
Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and other asset-based securities. He provides Lullum with a list of credit enhancements for asset-backed securities, which includes letters of credit, excess servicing spread funds, overcollateralization, and bond insurance.
Lullum then asks him for a status report of the firm's exposure to paythrough securities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate the prepayment for the month for a seasoned mortgage pool with a $500,000 principal balance remaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate (CPR) is 7%.
Van Ark computes the convertible bond's market conversion premium per share (MCPPS) using only the information given, and then wants to know how a sudden increase in the stock price of $2 would impact the bond price. Which of the following choices is most correct?
A. The sudden $2 increase would have a large effect.
B. The original MCPPS is $60 per share.
C. The sudden $2 increase would have a small effect.
Answer: C
Explanation:
Explanation/Reference:
Explanation:
The MCPPS is the difference between the conversion value and the bond's current market price, on a per share basis.

Regarding the stock price increase, the
convertible bond is essentially a straight bond (i.e., no conversion privilege), plus a call option on the underlying common stock. In this case, the option is far out of the money. So, while the increase in the stock price will have a positive impact on the bond, the impact will be small because the delta is close to zero for options that arc far out of the money (Study Session 14, LOS 57.i)

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