Finance 473

1. What are on-the-run and off-the-run issues?

On-the-run issues are recently issued Treasury securities; they are the most liquid securities with a very narrow bid-ask spread. Off-the-run issues are Treasury securities issued earlier; they are not quite as liquid and can have slightly wider spreads.

2. Which bond has the greatest price sensitivity to interest rate changes? (3 pts)

a. 6 month zero-coupon bond.

b. 10 year zero-coupon bond.

c. 5-year 3% annual coupon bond.

d. 10 year 5% coupon bond callable after 7 years.

B

1. On Nov 8st, 2012 we observe  that the CDS spread on MBIA Insurance Corp increased by roughly 75%.  

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What can you say about risks associated with MBIA Insurance . (3 pts)

Default risk went up.

1. From Bloomberg: “Ginnie Mae-guaranteed mortgage securities are trading near record premiums over Fannie Mae bonds. Bloomberg (12/1/2008)” Why?

Investors are targeting notes considered by regulators to be the least risky, and debt with the strongest backing from the government. "If you’re an international buyer, you lean toward Ginnies because you’d rather have the full-faith-and-credit backing at any reasonable difference in spreads," said Peter Hirsch of Royal Bank of Canada’s RBC Capital Markets unit.

1. Assume the following yield curve for zero-coupon bonds:

1. What is the Macaulay duration of each of the bonds?
2. Assume you want bond portfolio duration to be equal to 3 years and you want to buy bonds with one- and four-year maturities.  What percentage investment should be made in each?

a. For zero-coupon bond, Macualey’s duration is equal to the bond’s maturity.

b. Bond immunization requires constructing a bond portfolio with a duration equal to your horizon date of 3 years: HD = Dp:

          HD  =  Dp

                     3  =  w1 D1  +  w2 D2 

                   3  =  w1 D1  +  (1-w1) D2 

                    3  =  w1 (1) +  (1-w1) (4)

                w1 = 1/3

                w2 = 2/3

1. What would an investor pay for a four-year, 9% annual coupon bond (face value of $1,000 and paying coupons annually) if the bond were trading to yield 10%?  What would the investor receive (full price) if she sold the bond 3.5 years later and bonds with maturities of .5 years were trading at 8%? Use 30/360 day count convention.

Purchase Price = $968.30, Selling Price (full) = $1048.85

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1. Bond X is a one-year PDB(=zero-coupon bond) with face value of 1000 trading at $945 and Bond Y is a two-year PDB with a face value of 1000 trading at $870:

1. Determine algebraically the implied forward rate f11.
2. Explain how the forward rate can be attained by a locking-in strategy.

a. The YTM on Bond X and Bond Y are:

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The YTM on Y (the 2-year bond) is the geometric average of YTM on X (the 1-year bond) and the implied forward rate on a one-year bond one from now: