Homework3a

Bond Markets, Analysis and Strategies (6th Edition)

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Homework #3 1) a) A US Treasury security is viewed as having no credit risk associated with it. b) The US Treasury is viewed as having no credit risk; this means that the future cash flows of the debt are certain and will be paid. Consequentially, the lack of credit risk leads to a low overall level of risk associated with the Treasuries. Therefore, since a debt instrument cannot have lower risk than that of a US Treasury, the US Treasury is viewed as a base interest rate . c) The phrase “on the run” refers to the most recent issue of Treasury bonds and notes. d) The phrase “off the run” refers to all issues of Treasury bonds and notes prior to the most recent issue. e) Basic yield spread = new bond A – old bond B i) Basic yield spread between off the run 10yr and on the run 10yr 6.87% – 6.89% = (- .02) or -2 bps spread ii) Basic yield spread between off the run 30yr and on the run 30yr
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Unformatted text preview: 7.08 – 7.12 = (-.04) or -4 bps spread f) The decrease in yield reflects lower expectations of risk (i.e. lower risk of inflation) 2) Refer to Excel sheet please 3) Although it is true that forward rates are typically poor predictors of actual future rates, they are far from being of little value to the investor. The investor’s prediction of future rates allows him to attempt to hedge against what he believes the future rates will be; thus, enabling him to make educated decisions about his investments. 4) Lend the forward rate, lend the six month spot rate, and borrow the one year spot rate. Period 1 2 Lend 6mo forw. rate 0.00-1.00 1.20 Lend 6mo spot rate-.901 1.00 Borrow 1yr spot rate .948-1.20 Net .047 6mo forward rate calculation: 1 + .4/2 6mo spot rate DF calculation: 1 / [1+(.2/2)] 1yr spot rate DF calculation: [1 / [1+.25/2]^2] x 1.20 (forward rate)...
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This document was uploaded on 04/07/2008.

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