FINAL EXAM
This final is graded on a total of 30 points.
Today is April 9th ,2002.
Turkish Sahan Bank (SB) top fixed income portfolio manager, Lionel Dahan, runs a portfolio with the following securities (par value):
$50 Million 90-day T-Bill quoted at 6 with a duration of 0.5 and convexity of 7
$100 Million of Bond ABC 7% (semi annual coupon) maturing on January 20 , 2012 trading at 102 with a duration of 8.5 and a convexity of 52
$250 Million of bond XYZ 5% of 2006 (maturity April 9th) that pays annual interest.
Convexity is 21 The risk free rate today is 6%.
1. What is the 90-day T-bill cash price ? ( 1point) 2. What is the price of Bond XYZ? (2 points)
3. What is the modified duration of Bond XYZ ? (2 points) 4. What is the portfolio’s overall modified duration? (2 points)
5. Co-manager, and awaiting a huge bonus this year for outstanding performance, trader Noël recommends the additional purchase of some ABC Bond. What would be the total cost, per bond, including accrued interest?( 1point)
6. Using duration and convexity, how would the portfolio’s percentage change if rates increase by 200BP ? (2 points)
7. Technical analyst expert Rodolphe Roche warn his traders that the interest rate futures chart shows a head and shoulder formation with a break of the neckline, probably leading to a further increase in rates. Swap traders , Cros and Cagnes, decide to swap ABC bonds for XYZ bonds while keeping the duration of their portfolio the same.
How much in market value of bond XYZ bonds (or how many XYZ bonds) should be purchased so that the portfolio dollar duration remain the same? (4 points)
Deutsche Bank (DB) Credit Derivatives analysts, Krings, Klien expect short-term interest rates to increase in the close future and are considering swapping some of their bonds with Sahan Bank.
Sahan Bank’s rating by Moodys is BB and Deutschbank’s rating is AA.
8. Because of the extreme volatility of the Turkish political situation, SB has agreed to pay DB Libor +0.9% and receive 6% per annum (semi-annual payments) on a principal of a principal of $100 million. The swap has a remaining life of 1.75 years. The yield curve is flat at 5%.The 6-month LIBOR rate at the last payment was 5.5%.
9. What are the risk, if any, encountered by DB ? Explain(1 point)
Below are fixed and floating rates at which each bank can borrow on the open credit market :
FIXED FLOATING
SAHAN BANK 9% Libor + 0.9%
DEUTSCHE BANK 6% Libor + 0.4%
10. Which bank has a comparative advantage in floating rates? Explain (1point) 11. Sahan Bank requires a fixed rate loan and DB requires a floating rate loan
Design a swap that will net Chouardot Investment Bank (CIB) acting as the investment bank a fee of 0.3% per annum and that will appear equally attractive for both SB and DB. (3 points)
The life insurance department of Sahan Bank, headed by Paez (a native Turkish) and Rollin ( a native Istambouli!) have a great deal going. A extremely wealthy Middle Eastern client, just opened an account with $25million. This client, very demanding and always asking questions, would be satisfied with a 10% return on his assets on a 3-year period. Paez and Rollin can use a 13% immunized rate of return.
12. What is the targeted client future value considering semi annual payments ? (1 point)
13. What is the safety cushion that Paez and Rollin have ? (2 points)
14. Now, suppose the funds are invested in a 10-year 12% junk bond selling at par with
A duration of 6.
What is the value of the portfolio if rates decrease to 9% after 1 year? (2points)
15. Would the portfolio managers have to immunize the portfolio if rates increase to 14% within a year. Show calculations (3 points)
