Tutorial 1 Solutions

He bought it at 857251 to a yieldtomaturity of 15

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Unformatted text preview: ic Forward Rate Agreement. Answer: This is accomplished by trading a series of zero coupon bonds so as to simulate FRA cash flows at time 0, time t, and time t + s. Short at time 0 the present value of a zero coupon bond, maturing at time t. At time 0 buy the exact same dollar value of zeros, which mature at time t + s. Question 6: Yield‐to‐Maturity and Coupon Rates An investor invests in a 4‐year 10%‐coupon bond paid annually. He bought it at 85.7251 to a yield‐to‐maturity of 15%. Assuming that the investor will hold the bond to maturity, and that there are no interest rate movements during that time, what is the net earning by the investor from this investment? Choose the correct answer from the following. EXPLAIN your answer. a) The net earning is equivalent to the coupon payout he receives. That is 10% b) The net earning is equivalent to the yield‐to‐maturity. That is 15% c) The net earning when the bond matures is growth from the price that the bond was bought to the face value at maturity. So net earning = [(100/85.7251)^(1/4) ‐1] d) None of the above. (If this is your answer, please provide the a numerical answer you think is correct) Answer: (b) Bond Price YTM Coupon 85.7251 15% 10% Year Price gain from Yield = [Bond Price * (100%+YTM)] [Price gain from Yield - coupon] 98.58 101.87 105.65 110.00 88.58 91.87 95.65 100.00 1 2 3 4 Value after coupon Payment = Consider the cash flows from the bond in the table above. At the end of year 1, the price of the bond gains value by 15% (yield to maturity) to 98.58. After the coupon payment, the bond value drops by 10 (i.e. coupon rate*face value = 10%*100 = 10) to 88.58. We can keep iterating this to maturity in year 4. The final cashflow (i.e. value of bond) is at 100, which is equal to the face value. This shows that the net‐earning is equal to the yield‐to‐maturity, which is at 15%. 2...
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This note was uploaded on 01/28/2013 for the course SEEM 5840 taught by Professor Doctorw during the Fall '12 term at CUHK.

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