2009 Practice Exam Question #36

[intuit2k2]

in 2009, Question 36

Your firm's finxed income portfolio has interest only CMOs, callable corporate bonds, inverse floaters, noncallable corporate bonds. Your boss wants to know which of the following securities can lose value as yields decline...

Answer c: IO strips and callable corporates

Don't understand why callable corporate will lose value. Yes, there's negative convexity on that end of the price/yield curve but the securies should never go down in value but is instead capped at call price. Is this a bad question?

 

[David Harper CFA FRM]

I think it's a bad question, see http://www.bionicturtle.com/wiki/FRM2009.E2.36/
there is a long thread discussion somewhere in the forum that i can't seem to find, some debate but it didn't persuade me. I agree with you: negative convexity yes, but that does not imply negative duration. David

 

[intuit2k2]

Are GARP's practice exams essentially a collection of reject questions, or do some of these question pop up on the test?

 

[David Harper CFA FRM]

They do make errors, the further back you go, the greater the error rate. But, they've gotten better (e.g., we feed them all back) and, in truth, IMO, everybody makes some errors (I sure do), every book, every exam etc ... sometimes they just go unnoticed, whereas we air them out .... the worst error types from previous exams i think have been ironed out...David