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Fixed Income Assignment 1

This document outlines an assignment for a fixed income securities course. It includes 6 problems dealing with concepts like discounting, accrued interest, yield curves, floating rate bonds, and synthetic bonds. Students must complete the problems in groups, showing their work, and submit their answers and Excel files by the assignment deadline. Late submissions will not be accepted and copying from past assignments is considered an honor code violation.

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Rattan Preet Singh
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172 views3 pages

Fixed Income Assignment 1

This document outlines an assignment for a fixed income securities course. It includes 6 problems dealing with concepts like discounting, accrued interest, yield curves, floating rate bonds, and synthetic bonds. Students must complete the problems in groups, showing their work, and submit their answers and Excel files by the assignment deadline. Late submissions will not be accepted and copying from past assignments is considered an honor code violation.

Uploaded by

Rattan Preet Singh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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MGT 6769 - Fixed Income Securities

Assignment 1 Prof. Hsu

This assignment must be submitted by the end of class on Wednesday, Feb. 15th , 2017.
Late submissions will not be accepted. The assignment questions are to be completed in
groups. You may complete all the problems entirely in the MS Excel spreadsheet. You
can also complete it using word documents with Excel spreadsheet attachments. Please
HIGHLIGHT your final answers. The assignment will be marked based on (1) how you
arrive at the solution, (2) is the solution correct or does it make sense? (3) the presentation
of your results. Remember, you must present your work in a clear and concise manner.
Show your work! Please keep in mind that copying assignments from past years
is considered a honor code violation, and it will hurt your ability to perform on
the exams.
1. Discounting - 10 points

• What is $100 invested today worth at the end of 25 years at an annualized interest
rate of 9% if compounded: (a) Continuously, (b) Quarterly, (c) Semi-annually, and
(d) Annually?
• What is the present value of a security which pays the certain cash flow streams
of $80 at the end of the first year, $90 at the end of the second year, $100 at the
end of the third year, and $120 at the end of the fourth year with an annualized
discount rate of 5% if compounded: (a) Continuously, (b) Quarterly, (c) Semi-
annually, and (d) Annually?

2. Accrued Interest - 15 points


There is a 4 percent coupon T-note trading in the market today. Its next semi-annual
coupon payment is in 53 days. After this coupon payment, the T-note has 9 more semi-
annual coupon payments and a final face value payment of $1,000. The quoted asked
yield is currently 2.3 percent (compounded semi-annually). The settlement will occur
in 2 days. The number of days in the current semi-annual period is 183 days. What
is the full (or dirty) price and what is the clean price? Also, what accrued interest
do you owe the current owner at settlement? Hint: Calculate the full price first,
then the interest, and finally the clean price.
3. Term Structure of Discount Rates - 15 points
On May 15, 2000 you obtained the data on Treasuries in Table 2.5 of Veronesi’s book.
Compute the semi-annual yield curve, spanning over 9 years, from the data using the
bootstrap procedure.
4. Floating Rate Bonds - 20 points
Today is March 15, 2000, and the current, semi-annually compounded yield curve is in
Table 2.4 of Veronesi’s book. Compute the price of the following floating rate bond:

1
• 10 year coupon bond maturing on June 15, 2004.
• Coupon paid semi-annually.
• Spread of 2%.
• Face value of $1,000.
• The 6-month interest rate on December 15, 1999 was 6%.

5. Synthetic Bonds, Arbitrage, Yield to Maturity, and Pricing - 20 points


Consider the following four default-free bonds traded in the market. All bonds mature
at or before the end of year 4. Their prices and cash flows at the end of each year are
the following:
Bond Price CF Year 1 CF Year 2 CF Year 3 CF Year 4
A 127.20 10 10 10 110
B 18.80 0 20 0 0
C 55.80 0 30 30 10
D 27.80 10 0 10 10

(a) What is the yield to maturity (simple compounding) of a new Bond E that matures
at the end of year 4 and provides cash flows of 15, 15, 15, and 130 on years 1
through 4, respectively?
(b) A new Bond F will be launched in the market. It will provide a yield to maturity
of 2.828688% (simple compounding) and cash flows of 200, 200, 400, and 1500 at
the end of years 1 through 4, respectively. Is there an arbitrage oppourtunity? If
so, work out an investment strategy to lock in an arbitrage profit today with no
future net cash flows.

6. Synthetic Bonds, Arbitrage, and Pricing - 20 points


There are six default-free bonds on the market. All of them mature at or before Year
6. Their prices today and cash flows at the end of each year are the following:
Bond 1 Bond 2 Bond 3 Bond 4 Bond 5 Bond 6
Price 84.0932 99.414 113.3659 178.4267 175.9827 107.324
Year 1 6 7 8 13 9 10
Year 2 6 8 11 14 11 110
Year 3 6 9 12 15 13
Year 4 6 10 14 16 200
Year 5 6 11 16 17
Year 6 106 113 116 210

My cash needs at the end of each year are the following:


Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
10 9 13 15 16 178

2
(a) How do I use these six bonds to construct the exact cash flow I need?
(b) If you were going to issue a bond with the exact cash flow that I need, what
should the price of that bond be?
(c) Repeat the exercise in part (a) except that for Bond 4, the final payment at the
end of Year 6 has been changed. Instead of $210, it’s now $219. What do you
find? Why?

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