FIXED INCOME MIDTERM MARCH 2005
(Total points = 50)
Today is March 3rd.
1. List 5 factors that affect the price of a bond.(2 points)
2. You wish to purchase 100 bonds of handout 1. What is your clean price considering a 5-days settlement? (2 points)
3. What are the advantages of a call feature for a bond issuer? (2 points) 4. T/F (2 points)
a) Government bond issues require a sinking fund payment of not less than 1% of the outstanding issue
b) A bond’s price is determined by its coupon rate, length to maturity and the prevailing yield in the market.
c) The secondary bond market is significantly more active than the stock market d) A customer wishing to hedge a future deposit would buy an FRA.
5. List 4 major differences between an FRA and a futures contract. (2 points)
6. Using the bid zero rates (or spot rates) confirm the price of the Mac Donald (MCD) bond of Handout 2. Interpolate the 1.5 year zero rate by averaging. (3 points)
7. You borrow $10 million for 1 year (365 days) and deposit it for 6 months (183 days). You wish to hedge the mismatched position based on the following FRA prices quoted to you on Handout 3.
a) Do you buy or sell the FRA? (1 point)
b) At what price? (be careful on the bid/ask side, whether you’re buying or selling the FRA. No middle rate here!) (2 points)
c) For a complete hedge, what amount do you deal? (3 points)
When it comes to fixing the FRA six month later, the 6-month rate is 4.25%/4.35% d) What is the settlement amount? Who pays who? (1 point)
e) What is the overall profit or loss of the book at the end of 1 year assuming that your borrowings are always at LIBOR and your deposits at LIBID? (2 points) 8. What is the estimated cash price of a 15-year bond paying an annual coupon of 7.5%
and yielding 9%? Show calculation. (1 point)
10.Use all handouts if necessary for this question. An investor likes a 5 year Caterpillar bond paying 10% coupon but anticipates a rise in rates in the next 1 year. What can he do to protect himself using FRAs? He wishes not to sell the bond. (2 points)
11. You own the following portfolio on March 3, 2005: Al bonds pay interest annually.
Face value Price Coupon Maturity Estimated Mod.Duration
Convexity
BOND A 10 million 88.50 5% 3/3/2011 5.25 42
BOND B 5 million 111 12% 3/09/2009 ? 20
BOND C 15 million 94.70 6% 3/3/2010 4.45 30
a) Using the estimation formula for YTM, find Bond B’s duration. Do not use your calculator yield. (2 point)
b) What would be the portfolio’s value, using duration and convexity, if rates moved up by 150BP? (2 points)
c) You expect rates to rise and would like to modify your portfolio’s duration by 20% using the futures market. The 10 year Tbond futures trades at 112:24 and the 5-year Tnote futures contract trades at 108:16. Volatility on both contracts are 18% for the 10-year and 11% for the 5-year. Duration for both contracts are respectively 9 and 4. The portfolio has a volatility of 7%.
What would you recommend doing? (3 points)
12.Here are the bids on the latest $15 billion 10 year Treasury auction. The Fed requires $5 billion.
Merrill Lynch: $5billion @4.36% Goldman Sachs: $4 billion @4.31% JP Morgan: $3 billion@ 4.29% Morgan Stanley: $3 billion@ 4.27%
Who gets what, and what is the Fed’s price on its bid? (2 points)
For the following questions, please be as specific and simple as possible. I am looking for key words and exact reasoning in your answers.
13.Explain the concept of “cheaper to deliver” in a maximum of 3 lines. Be specific, not vague in your writing. (3 points)
14.Explain the title: “Treasuries fall as Korea looks to diversify its reserve holdings” (3 lines max.) (3 points)
17.Explain why a downgrade of GM bonds would push yields much higher in the junk bond sector. (3 points)
