Equity & Fixed Income

Q1. (3 marks)

• Equity represents ownership in a company; each share is a fractional claim on the company's assets and earnings (1).
• As an asset class, equities offer potential capital appreciation and dividends, with higher expected return and higher risk/volatility than fixed income (1).
• Any two rights: voting rights, right to dividends, residual claim on assets in liquidation, right to information (1).

Q2. (3 marks — 1 each)

• (a) Coupon rate: the fixed annual interest paid by the bond, expressed as a % of face value.
• (b) Face value: the principal amount repaid to the holder at maturity (par).
• (c) Maturity: the date/time when the principal is repaid and the bond expires.

Q3. (4 marks — 2 per difference)

• Government bonds are issued by a sovereign/government; corporate bonds by companies (2).
• Government bonds carry lower default (credit) risk and hence lower yields; corporate bonds carry higher default risk and offer higher yields as compensation (2).
• (Accept: taxation differences, liquidity differences.)

Q4. (4 marks)

• Current yield $= \dfrac{\text{Annual coupon}}{\text{Price}}$.
• (a) $= \dfrac{80}{1000} = 0.08 = 8\%$ (2).
• (b) $= \dfrac{80}{1250} = 0.064 = 6.4\%$ (2).
• Why: coupon is fixed; as price rises, yield falls (inverse relationship).

Q5. (4 marks)

• Statement: Bond prices and yields move in opposite directions — when yields rise, prices fall, and vice versa (2).
• Why: A bond's price is the present value of fixed future cash flows. A higher discount rate (yield) lowers the present value of those fixed cash flows, so the price falls (2).

Q6. (4 marks)

• Formula: $P = \dfrac{FV}{(1+y)^n}$ (1).
• $P = \dfrac{1000}{(1.06)^5}$ (1).
• $(1.06)^5 = 1.338226$ (1).
• P = \dfrac{1000}{1.338226} = \747.26$ (1).

Q7. (4 marks)

• (a) Credit ratings measure the creditworthiness / likelihood that the issuer will repay debt (default probability) (1).
• (b) AAA = investment grade; BB = speculative; AA = investment grade; C = speculative (2) (½ each).
• (c) Default risk: the risk that the issuer fails to make promised coupon or principal payments (1).

Q8. (6 marks — 2 per shape)

• Normal (upward-sloping): long-term yields > short-term yields; signals healthy/expanding economy with expectations of growth/inflation (2).
• Inverted (downward-sloping): short-term yields > long-term yields; often signals expected economic slowdown/recession (2).
• Flat: short- and long-term yields roughly equal; signals transition/uncertainty about future economic direction (2).

Q9. (4 marks)

• (a) Duration measures the sensitivity of a bond's price to interest rate changes; also the weighted-average time to receive cash flows (2).
• (b) $\%\Delta P \approx -\text{ModDur} \times \Delta y = -7 \times 0.005 = -0.035 = -3.5\%$ (2). Price falls approximately $3.5\%$.

Q10. (3 marks)

• Debenture: an unsecured/long-term debt instrument backed only by the issuer's creditworthiness (not by specific collateral) (1).
• Convertible bond: a bond that can be converted into a predetermined number of the issuer's equity shares (1).
• Advantage of convertible: investor benefits from equity upside if share price rises, while enjoying bond income/downside protection until conversion (1).

[
  {"claim":"Current yield at price 1000 is 8%","code":"result = (80/1000 == 0.08)"},
  {"claim":"Current yield at price 1250 is 6.4%","code":"result = abs(80/1250 - 0.064) < 1e-9"},
  {"claim":"Zero-coupon bond price = 747.26","code":"P = 1000/(1.06**5); result = abs(P - 747.258) < 0.01"},
  {"claim":"Modified duration price change is -3.5%","code":"result = (-7 * 0.005 == -0.035)"}
]