Chapter11 - Chapter Eleven Fundamentals of Interest Rate...

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Chapter Eleven Fundamentals of Interest Rate Futures Answers to Problems and Questions 1. Unlike shares in a particular common stock or bushels of inspected soybeans, not all Treasury bonds are identical. Differences in coupon rate and in maturity are material, because they influence the level of interest rate risk associated with the bond. Bonds with high coupons are more desirable than bonds with low coupons if everything else is held constant. High coupons that last for a long time are particularly attractive. Conversions are necessary to provide greater flexibility during the bond delivery process, because there is only a limited quantity of bonds with the precise characteristics described in the futures contract. 2. The bond equivalent yield allows more direct comparison among investment alternatives. The two key adjustments made by this calculation are the fact that there are 365 days in a year rather than 360, and the fact that the actual investment required is the discounted price, not the face value. 3. Money market funds are short term in nature. It would not be desirable to hedge short term rates using a long term instrument. 4. A bond that is callable is not fungible with a non-callable bond. To standardize the contract and ensure users know what they are dealing in, the provision about call protection is needed. 5. An especially good example is a fund manager who will soon receive money to invest in short-term money market securities and wants to lock in the current rate. 6. Interest rate risk increases with the duration of the fixed income securities,
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This note was uploaded on 01/31/2011 for the course ACCT 331 taught by Professor N/a during the Spring '10 term at Mountain State.

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Chapter11 - Chapter Eleven Fundamentals of Interest Rate...

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