Tutorial 1 Solutions

# Question4 suppose we own a 7year 6 coupon bond with a

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Unformatted text preview: ave: 1 Transaction today T=0 T=1 T=2 Sell 1.0700237 two-year 0.881659*1.0700237 0 -1.0700237 zero-coupon bonds = 0.943396 Buy 1 one-year zero -0.943396 +1 coupon bond Lend 1 from year one to -1 +1.07200 year two @ 7.2% TOTAL 0 0 0.0019763 We see that we have created something out of nothing, without any risk involved. We have indeed found an arbitrage opportunity. Question 4: Suppose we own a 7‐year, 6% coupon bond with a yield of 7%, and want to find the duration‐matched short position in a 10‐year, 8% coupon bond yielding 7.5%. Assuming annual coupon payments, the Duration and Price of the bonds are 5.882 years and \$94.611 and 7.297 years and 103.432, respectively. If you own one of the 7‐year bond, how much of the 10‐year bond must you hold in order to be immune to interest rate movements? Answer: If we hold 1 unit of the 7‐year, we need ‐0.7408 units of the 10‐year. (See equation in problem set 1, question 3 solutions) Question 5: Explain the process of creating a synthet...
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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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