Solution 2

Solution 2 - Fin 448: Fixed-Income Securities Homework...

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Fin 448: Fixed-Income Securities Homework Solution 2 Wei Yang 1 Quoting T-bills (1.1) quote = 100 - 98 100 × 2 1 = 4% (1.2) yield = ± 100 98 - 1 ² × 2 1 = 4 . 08% 2 Basis point value (2.1) Note that we are investing $100M. This is not the face value. D 5 = 4 . 45806 P = 10 8 DV 01 = $44580 . 6 (2.2) Per $1M face value P 2 = 1 M , DV 01 2 = 190 . 39 P 10 = 0 . 922 M , DV 01 10 = 742 . 64 Suppose we invest a face value x M of 2-year bonds, and a face value y M of 10-year bonds. xP 2 + yP 10 = 100 xDV 01 2 + yDV 01 10 = 0 The results are x = 130 . 955 , y = - 33 . 5721 These are face values. The market values are xP 2 = 130 . 955 , yP 10 = - 30 . 955 1
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We buy 2-year bonds and short 10-year bonds. Note that the value of the entire portfolio is $100M. By shorting 10-year bonds, we create leverage to buy 2-year bonds worth more than $100M. In solving this problem (and the lecture example), we calculate DV 01s based on 1M face values, instead of 1M market values (or prices), only because the formulas are easier to use with face values. When we invest (establish short and
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Solution 2 - Fin 448: Fixed-Income Securities Homework...

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