(L06)CapBudget(f)2

# (L06)CapBudget(f)2 - xxx px p x px F x C x C x y F C x C x...

This preview shows pages 1–13. Sign up to view the full content.

Primbs/Investment Science 1 Lecture 6: Applied Interest Rate Analysis Reading: Luenberger Chapter 5, Sections 1 – 2, 6

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 2 Applied Interest Rate Analysis Capital Budgeting Cash Matching Valuation of a firm
Primbs/Investment Science 3 Cash Matching Problem A series of future obligations must be met. You have various bonds you can invest in. You would like to construct a portfolio to meet the obligations at minimum cost. (Compare and contrast this with immunization)

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 4 Cash Matching in Pictures Obligation: Bond 1 F 1 Bond 2 F 2 C 2 Bond 3 F 3 C 3 Can invest in these to meet obligation
Primbs/Investment Science 5 Cash Matching in Pictures Obligation: Bond 1 Bond 2 Bond 3 F 1 F 2 F 3 C 2 C 3 x 1 x 2 x 3 # of bonds Choose portfolio of minimum cost that has enough money to meet the obligation.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 6 Cash Matching Assumptions Can solve the cash matching problem under different assumptions: 1) No reinvestment of excess cash is allowed. 2) Excess cash can be held at zero interest rate from one period to the next. 3) Excess cash can be reinvested at the appropriate forward rate.
Primbs/Investment Science 7 Cash Matching in Pictures Obligation: Bond 1 Bond 2 Bond 3 F 1 F 2 F 3 C 2 C 3 x 1 x 2 x 3 # of bonds y 1 y 2 y 3 1 3 3 2 2 1 1 y x C x C x F + + 1 1 2 3 3 2 2 2 ) ( y x C x C F + + 2 2 3 3 3 3 ) ( y x C F + 3 3 p 1 p 2 p 3 Price of bonds 3 3 2 2 1 1 , , 3 2 1 min x p x p x p x x x + + Without reinvestment C 2 C 3 C 3

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 8 Cash Matching in Pictures Obligation: Bond 1 Bond 2 Bond 3 F 1 F 2 F 3 C 2 C 3 x 1 x 2 x 3 # of bonds y 1 y 2 y 3 1 1 3 3 2 2 1 1 y z x C x C x F - + + 0 1 z 1 1 2 2 1 3 3 2 2 2 ) ( y z z x C x C F - + + + 0 2 z 2 2 3 2 3 3 3 ) ( y z x C F + + 3 3 p 1 p 2 p 3 Price of bonds 3 3 2 2 1 1 , , 3 2 1 min x p x p x p x x x + + With reinvestment at zero rate C 2 C 3 C 3
Primbs/Investment Science 9 Cash Matching in Pictures Obligation: Bond 1 Bond 2 Bond 3 F 1 F 2 F 3 C 2 C 3 x 1 x 2 x 3 # of bonds y 1 y 2 y 3 1 1 3 3 2 2 1 1 y z x C x C x F - + + 0 1 z 1 1 2 2 1 2 , 1 3 3 2 2 2 ) 1 ( ) ( y z z f x C x C F - + + + + 0 2 z 2 2 3 2 3 , 2 3 3 3 ) 1 ( ) ( y z f x C F + + + 3 3 p 1 p 2 p 3 Price of bonds 3 3 2 2 1 1 , , 3 2 1 min x p x p x p x x x + + With reinvestment at forward rate C 2 C 3 C 3

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 10 Bonds 1 2 3 4 Coupon 3% 4% 2% 5% s(0,i) f(i-1,i) d(0,i) Time 1 2 3 4 Amount Obligation 3% 3.0% 0.970446 1 103 4 2 5 10.502406 >= 10 3.50% 4.0% 0.932394 2 104 2 5 200 >= 200 4% 5.0% 0.88692 3 102 5 30 >= 30 4.20% 4.8% 0.845354 4 105 50 >= 50 Price 99.95589 100.8507 94.27156 102.711 Portfolio 0 1.894976 0.270775 0.47619 0 191.1097 25.52638 48.90998 265.54608 Total Price Cash Matching Term Structure Bonds No Reinvestment
Primbs/Investment Science 11 s(0,i) f(i,i-1) d(0,i) Time 1 2 3 4 Amount Obligation 3% 3.0% 0.970446 1 103 4 2 5 -1 10 >= 10 3.50% 4.0% 0.932394 2 104 2 5 1 -1 200 >= 200 4% 5.0% 0.88692 3 102 5 1 -1 30 >= 30 4.20% 4.8% 0.845354 4 105 1 50 >= 50 Price 99.95589 100.8507 94.27156 102.711 0 0 0 Portfolio 0 1.890324 0.270775 0.47619 0.4837985 0 0 Amount in 0 190.6406 25.52638 48.90998 0 0 0 265.07693 Total Price Reinvest at Zero Interest Reinvest at zero interest Bonds Term Structure

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Primbs/Investment Science 12 s(0,i) f(i,i-1) d(0,i) Time 1 2 3 4 Amount Obligation 3% 3.000% 0.970446 1 103 4 2 5 -1 10 >= 10 3.50% 4.000% 0.932394 2 104 2 5 1.0408108 -1 200 >= 200 4% 5.000% 0.88692 3 102 5 1.05127 -1 30 >= 30 4.20% 4.800% 0.845354 4 105 1.049171 50 >= 50 Price 99.95589 100.8507 94.27156 102.711 0 0 0 Portfolio 0.21037202 1.782777 0.262646 0.384342 21.24643 9.96928 9.192063 Amount in 21.0279227
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 52

(L06)CapBudget(f)2 - xxx px p x px F x C x C x y F C x C x...

This preview shows document pages 1 - 13. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online