Quiz Question
Consider a 4-year leveraged inverse floating rate
bond with the following coupon rate: c(t) = 24%2.4*r(t-0.5). This coupon is paid semi-annually,
in arrears. So the dollar coupon at each payment
date is given by: $coupon = c(t) / 2 * 100.
A
FIN 611: Overview of Concepts and Problems you should understand for the final exam.
Chapter #1: Introduction to Fixed Income Securities
1. Repo and reverse repo transactions
Chapter #2: Basics of Fixed Income Securities
1. Discount Factors and Interest R
Chapter 2, Exercise #1
Consider two zero coupon bonds.
Bond #1: 3-yr zero with yield = 10% per
year compounded continuously
Bond #2: 5-yr zero with yield = 5% per
year compounded continuously.
Is this scenario possible? What arbitrage
strategy could b
Solution Manual
to accompany the textbook
Fixed Income Securities:
Valuation, Risk, and Risk Management
by Pietro Veronesi
Chapters 2 - 8
Version 1
Date: October, 2009
Author: Anna Cieslak, Javier Francisco Madrid
Solutions to Chapter 2
Exercise 1.
Comput
Solution Manual
to accompany the textbook
Fixed Income Securities: Valuation, Risk, and Risk
Management by Pietro Veronesi
Chapters 9 - 13
Preliminary Version
Author: Javier Francisco Madrid
1
Solutions to Chapter 9
Exercise 1.
a. The expected return is e
AMERICAN OPTIONS
An American call option is a contract between
two counterparties in which one party (the option
buyer) has the right, but not the obligation, to
buy a given security at a predetermined price on
or before a maturity time T, and the other
A TWO-STEP BINOIMAL TREE
1
RISK NEUTRAL PRICING
We can obtain the price of any interest rate
security at time 0 by using the risk neutral
approach, that is:
V0 = e-r
p* =
0
[p* V1,u + (1 p*) V1,d]
e r0 P0 (2) P d (2)
1,
P u (2) P d (2)
1,
1,
= 0.6446
2
3
Mortgage Backed Securities
A mortgage pass-through security is a
simple type of MBS created by pooling
mortgage loans and issuing certificates
entitling the investor to receive a pro
rata share in the cash flows of the
specific pool of mortgage loans tha
Duration Hedging Strategy
Consider a $100 (face value) 10-year
bond that pays a 5% semi-annual coupon
P = $103.58
D = 8.03
C = 73.87
We want to hedge against small parallel
shifts of the term structure.
We will need to enter into a position in an
ad
Term Structure Models:
Motivation
Assume that you have estimated the
current discount function Z(0,T).
If you were asked to price a 10%, 5-year
T-bond you would compute the price as:
10
P (0) = 5 Z (0, Ti ) + 100 Z (0,5)
i =1
1
Term-Structure Models
But
Example #1
You have the following risk neutral Tree:
Time
0
1
2
3
i
0
1
2
3
j=0
4.00%
7.00%
10.00%
3.00%
5.00%
1
2
2.00%
Risk neutral probability of an up move =
0.5
Example #1
Compute the 1, 2 and 3 year zero coupon
bond prices.
Compute the swap rate c(3
INTEREST RATE FUTURES
Futures contracts are similar to forward
contracts in that they are contractual
agreements between two counterparties to
either buy or sell a security at a
predetermined time in the future and for a
predetermined price, called futur
Forward Rates
Suppose a firm want to invest $100 million
for 6 months starting 6 months from now.
It wants to lock in the interest rate that it
would earn on the 6-month loan today.
What rate would a bank offer on this loan?
Answer: The forward rate f
FIN 611
Fixed Income Analysis
Welcome to the course.
Mike Inglis
Office: TRS 1-085
Office Hours: Thursday 12 noon to 1 pm.
E-mail: [email protected]
Overview of Course
Part 1: Cover the basics of fixed income
pricing, risk and risk management:
Mark