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3 views3 pages

Fins2624 PS2 T12024

Uploaded by

Manager Prima
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FINS2624: Portfolio Management

2024 Term 1:Assignment 2 due 25/02/2024


Only handwritten solutions accepted
Zid:
Signature:

Q1 Suppose the pure yield curve is currently given by

Spot Rate
y1 4%
y2 5%
y3 6%

A 3-year 6% annual coupon bond with a face value of $100 is currently trading in the market and
is priced using the pure yield curve.
a. Without calculating the yield to maturity on the bond, will it be equal to, higher or lower
than the 3-year spot rate y3? Explain why?
b. Without calculating the price of the bond, will it be a par, premium or discount bond?
Explain why?
c. If after the bond is purchased, the yield curve shifts down uniformly by 0.5%. Will the
price of the bond stay the same, increase or decrease?
If the bond is held to maturity, will the realized compound yield be equal to, higher or lower
than the yield to maturity on which the bond was purchased? Will it be equal to, higher or
lower than the 3-year spot rate y3 when the bond was purchased? Explain why?
Q2 Suppose the following bonds are trading in the market.

Bond Time-to-Maturity Face value Coupon rate Price


E 1 $ 100 0% $ 96.62
F 2 $ 100 5% $ 100.98
G 4 $ 100 0% $ 81.65

In addition to the bonds above, you also observe the 1-year forward rate in 2 year’s time 2f3 is
5.40%. You wish to price Bond H, which is 4-year 10% coupon bond with a face value of $100.
Assume all bonds (and the forward rate) are risk-free and that Bond F and Bond H are annual
coupon bonds.

a. Infer the term structure of interest rates: y1, y2, y3 and y4 (i.e. derive the pure yield curve for
years 1-4).

b. Price Bond H of the pure yield curve.

c. Based on the pure yield curve, infer the 2-year forward rate commencing in 2 year’s time 2f4.

d. Assume the Liquidity Preference Hypothesis holds and the annual liquidity premium is flat at
0.50% for all t. What is the expected future 1-year spot rate (i.e. the short rate) in 3 year’s time
E(3y4)?

e. Assume the Expectations Hypothesis holds. What is the expected 1 year future spot rate (i.e.
the short rate) in 1 year’s time E(1y2)?

Q3 Consider a four-year bond with a face value of $100 and a coupon rate of 15%. The term
structure of interest rates is flat at 6%, i.e. 𝑦𝑡 = 6% for all t.

a. Please calculate the duration of this bond, and use the duration rule to estimate the change in
price (in dollars) if the term structure of interest shifts to 7%?

b. What would be the actual price change?

c. Could you please explain the approximation error of using duration rule by the price-yield
curve and thus the relationship between yield and duration?

d. Now let’s assume that the convexity of this bond is 13.47. Please estimate the price change
by using both duration and convexity.

e. Would the dollar error using the duration approximation be larger or smaller if the term
structure would shift from 15% to 16% (instead of from 6% to 7%)? Why?
Q4 In this problem the term structure of interest rates is flat at 5%. The following bonds and
liabilities are given:
• Bond A: A zero-coupon bond with a face value of $100 and a time to maturity of 3 years.
• Bond B: A zero-coupon bond with a face value of $100 and a time to maturity of 6 years.
• Bond C: A zero-coupon bond with a face value of $100 and a time to maturity of 10 years.
• Liability X: A one-time liability of $100 maturing in 4 years.
• Liability Y: A one-time liability of $100 maturing in 8 years.

a. Suppose you have liability X and want to immunize it using bonds A and B. How would you
invest in each bond?

b. Suppose you have liability X and want to immunize it using bonds B and C. How would you
invest in each bond?

c. Suppose you have both liabilities X and Y and want to immunize your position using bonds
B and C. How would you invest in each bond?

Q5 Consider the following bonds:


• Bond A: A 2-year zero-coupon bond with a face value of $100 and 6% YTM.
• Bond B: A 2-year par-value bond with a face value of $100 and 6% coupon.
• Bond C: A 2-year par-value bond with a face value of $100 and 7% coupon.
• Bond D: A 3-year par-value bond with a face value of $100 and 7% coupon.
• Bond E: A 4-year par-value bond with a face value of $100 and 7% coupon.
• Bond F: A 4-year discount bond with a face value of $100 and 7% coupon.

If the yield curve shifts upwards by one percent,

a. Which bond among bonds A, B and C will experience the largest percentage price change?
Which will have the lowest percentage price change?

b. Which bond of bonds C and D will experience a larger percentage price change?

c. Would you expect the difference in percentage price change to be bigger between bonds C
and D or between bonds D and E?

d. Which bond of bonds E and F will experience a larger percentage price change?

Marking: To obtain the full credit, you need to attempt all questions.

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