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The Following Information Relates to Questions

question 14

Multiple Choice

The following information relates to Questions
Megan easton is a portfolio manager with dynamo investment Partners (dynamo) and man-ages a bond portfolio that invests primarily in investment-grade corporate bonds with a limited
amount of US government bonds. easton meets with John avelyn, a newly hired analyst, todiscuss the structure and management of this investment portfolio, as well as some possiblechanges to the portfolio composition.easton begins the meeting by stating her belief that the credit spread is the single mostimportant measure that investors use when selecting bonds. among the various credit spreadmeasures, including the g-spread, i-spread, and Z-spread, easton prefers the g-spread.
easton and avelyn next discuss credit strategy approaches. dynamo uses a bottom-upapproach that selects bonds with the best relative value from the universe of bonds with similarcharacteristics. avelyn comments on the following considerations in a bottom-up approach. comment 1: callable debt has a smaller option-adjusted spread than comparable non-callable debt. comment 2: benchmark corporate bond issues normally have wider spreads than older bonds of the same issuer.
comment 3: The announcement of a new orporate bond issue often leads to an in- crease in the credit spread on the existing bonds.dynamo is changing the bond portfolio's investment constraints so that it can invest up to 20% of the assets in high-yield corporate bonds and 20% in structured financial instruments. easton makes the following statement about these changes:
liquidity and trading issues for high-yield bonds, such as investment-grade bonds, will be a key consideration in our security selection. although both high-yield and investment-grade bonds are quoted as spreads over benchmark government bonds, we must be aware that dealers are likely to hold larger inventories of high-yield bonds and their bid-offer spreads will be larger. avelyn makes the following statements about the differences between investment-grade and high-yield bonds.
Statement 1: When default losses are low and credit spreads are relatively tight, high- yield bonds tend to perform more like nvestment-grade bonds. Statement 2: investment-grade bonds have greater exposure to credit risk than high- yield bonds.
Statement 3: high-yield bonds have more exposure to interest rate risk than invest-ment-grade bonds. two of the structured financial instruments that easton and avelyn are considering for dynamo's portfolio are collateralized debt obligations (cdos) and covered bonds. easton and avelyn make the following comments about the securities. easton: if the correlation of the expected defaults on the cdo collateral of the sen- ior and subordinated tranches is positive, the relative value of the mezzanine tranche compared with the senior and equity tranches will increase. avelyn: replacing a portion of the corporate bonds with cdos will provide meaningful diversification to the investment portfolio. avelyn: investing in covered bonds will give us the yield increase we are seeking com- pared with investing in corporate bonds or asset-backed securities
-Which comment regarding cdos and covered bonds is accurate?

Definitions:

Observational Evidence

Information and data gathered through observing phenomena without manipulating variables, often used in studies where controlled experiments are not feasible.

Critical Thinking

The process of actively and skillfully conceptualizing, applying, analyzing, synthesizing, and evaluating information to reach an answer or conclusion.

Cause-Effect Conclusion

Logical determination that specifies how one event (the cause) directly leads to another event (the effect).

Skepticism

A philosophical attitude of doubting the veracity of knowledge claims in the absence of compelling evidence.