Homework 4

Homework 4 - You will create long and short positions by...

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Fin 448: Fixed-Income Securities Homework 4 Wei Yang Assigned: Apr 21 Due: Apr 28 Each problem counts as 10 points. 1 Spread trade using repos You are speculating that the spread between a corporate bond yield and the Treasury yield will narrow over the next 6 months. To make a profit, you will short Treasury bonds, and long the corporate bonds, and unwind the portfolios in 6 months right after next coupon payments. To avoid the consequences of any parallel shifts in the yield curve, you want to build a portfolio of zero DV 01. Both Treasury and corporate bonds have a 5-year maturity and are priced at par. The yields are 4% for the Treasury bonds, and 5% for the corporate bonds. Suppose the repo rates are equal to the respective yields. (1.1) What are the prices and DV 01 for the two bonds, each with a principal of $1M? (1.2) Suppose you decide to short Treasuries with a $1M principal. How much is the principal of the corporate bonds you need to long in order to create a zero DV 01 portfolio? What are the market values of the two positions?
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Unformatted text preview: You will create long and short positions by entering into repos and reverse repos. As-sume there is no haircut. We have shown in the class that the initial cash ows for these transactions are zero. (1.3) How much is the interest you need to pay back for the repo? How much is the interest you receive for the reverse repo? Suppose after 6 months, the Treasury bond yield has increased by 25 bp, while the corporate bond yield has increased by 10 bp. Note that the maturities have shrunk by 6 months, and both bonds have just paid coupons. You unwind the positions. 1 (1.4) How much is the coupon you receive for the repo? How much is the coupon you deliver for the reverse repo? (1.5) How much is net cash inow after you unwind long position? How much for the short position? (1.6) Overall, do you make a prot or a loss? How much? Alternatively, suppose after 6 months, both yields shift up by 15 bp. (1.7) How much is the prot or loss? 2...
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Homework 4 - You will create long and short positions by...

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