Q-1:

Given the (yearly) spot rate curve s = (4.8, 5.1, 5.4, 5.6, 5.8, 5.9), find the spot rate curve for next yea
Year (i)
Spot rate (S)
Spot rate (f 1, i)

1
4.80%

5.10%
5.401%

5.40%
5.701%

Using formula= f1,2 = (( 1+s2)^2/(1+s1)) - 1

Using formula= f1,2 = (( 1+s3)^3/(1+s1))^(1/2) - 2

Q-2:

Consider two 6-year bonds: one has a 10% coupon and sells for 108.00; the other has a 5% coupon and sells for 85.06. Find th

10 x + 5 y = 0
x+y =1
10 x + 10 y = 10
5 y =10

y=2
x= -1

-108 + 2*(85.06) = P
P=

Q-3:

62.12

( Book Prob. 4.11)

PVk = Cash Flow + dk,k+1* ( PVk+1)

Year

Cash Flow
1
2
3
4
5
6
7

Q-4:

Spot Rate
-40
10
10
10
10
10
10

Problem 4.13

Stream Immunization

5
5.3
5.6
5.8
6
6.1

Discount rate
d0,k
0.9523809524
0.9018685815
0.8491965975
0.7981000338
0.7472581729
0.7009833403

Discount rate
d k, k+1
0.9523809524
0.9469620106
0.9415968301
0.9398295237
0.9362963804
0.9380738355

Year
1
2
3
4
5
6
7
8
9
10
11
12
Total:
Duration:

Spot
7.67%
8.27%
8.81%
9.31%
9.75%
10.16%
10.52%
10.85%
11.15%
11.42%
11.67%
11.89%

P1:
P2:
Obligation:
Year
Cash Flow
1
500
2
900
3
600
4
500
5
100
6
100
7
100
8
50

d
0.93
0.85
0.78
0.70
0.63
0.56
0.50
0.44
0.39
0.34
0.30
0.26

B1
6
6
6
6
6
6
6
6
6
6
6
106

PV1
5.573
5.118
4.657
4.203
3.768
3.357
2.979
2.632
2.317
2.035
1.782
27.530
65.951

65.95
101.66

12 Year 6% bond.
5 Year 10% bond.

Spot Rate
PV
7.67%
464.381907681
8.27%
767.761333098
8.81%
465.74137337
9.31%
350.211519423
9.75%
62.8025612044
10.16%
55.9572594595
10.52%
49.6493841962
10.85%
21.9323124738
Sum
2238.43765091
Quasi modified duration of obligation

-PV1'
431.301
1418.235
1284.095
1281.535
286.116
304.778
314.464
158.285
5478.809
2.4476042424

Immunization Result
0%

1%

Bond1
Shares
Price
Value

-14.03
65.95
-925.10

-14.03
61.51
-862.87

Bond2
Share
Price
Value

31.12
101.66
3163.32

31.12
97.90
3046.42

Obligation Value

2238.44

2184.70

Bonds - Obligation

-0.22

-1.16

d the spot rate curve for next year

4

5.60%
5.868%

5.80%
6.051%

5.90%
6.121%

a 5% coupon and sells for 85.06. Find the price of a 6 year zero-coupon bond

eq 1
eq 2

PVk
9.4978767842 Running PVk = 9.497
51.972770623
44.323605545
36.452550017
28.146115172
19.380738355
10

Answer

-PV1'
5.176
9.455
12.841
15.378
17.167
18.287
18.868
18.994
18.763
18.262
17.551
295.257
465.999
7.066

B2
10
10
10
10
110

PV2
9.287638
8.530681
7.762356
7.00423
69.08282
0
0
0

-PV2'
8.626022
15.75816
21.40159
25.6307
314.7281
0
0
0

101.668 386.145
3.7981

6% bond.
10% bond.
P1*X1+ P2*X2 = PV
P1*D1*X1+ P2*D2*X2 = PV*D
65.951
466.0

x1=
x2=

* X1
*X1

+
+

101.668 *X2
386.1446 *X2

-14.02731
31.11665
Year

-1%
-14.03
70.84
-993.69

31.12
105.62
3286.54
2294.30

= 2238.438
= 5478.809

1
2
3
4

Spot
8.67%
9.27%
9.81%
10.31%

Cash FlowSpot Rate

1
500
8.67%
2
900
9.27%
3
600
9.81%
4
500
10.31%
5
100
10.75%
6
100
11.16%
7
100
11.52%
8
50
11.85%
Sum
d
0.92
0.84
0.76
0.68

B1
6
6
6
6

-1.45

5
6
7
8
9
10
11
12

10.75%
11.16%
11.52%
11.85%
12.15%
12.42%
12.67%
12.89%

1
2
3
4
5
6
7
8
9
10
11
12

Spot
6.67%
7.27%
7.81%
8.31%
8.75%
9.16%
9.52%
9.85%
10.15%
10.42%
10.67%
10.89%

0.60
0.53
0.47
0.41
0.36
0.31
0.27
0.23

6
6
6
6
6
6
6
106

0.94
0.87
0.80
0.73
0.66
0.59
0.53
0.47
0.42
0.37
0.33
0.29

B1
6
6
6
6
6
6
6
6
6
6
6
106

eq1
eq2

PV
460.109
753.773
453.133
337.684
60.018
53.004
46.6155
20.4118
2184.75
PV1
5.521
5.025
4.531
4.052

Year

B2
10
10
10
10

65.951
466.0

Cash FlowSpot Rate

1
500
6.67%
2
900
7.27%
3
600
7.81%
4
500
8.31%
5
100
8.75%
6
100
9.16%
7
100
9.52%
8
50
9.85%
Sum
PV2
9.202172
8.375256
7.552215
6.75368

101.668 2238.438
386.1446 5478.809

PV
468.735
782.143
478.822
363.325
65.7436
59.1043
52.911
23.5814
2294.37

3.601
3.180
2.797
2.449
2.138
1.861
1.615
24.742
61.514

110

PV1
5.625
5.214
4.788
4.360
3.945
3.546
3.175
2.830
2.514
2.227
1.967
30.662
70.852

B2
10
10
10
10
110

66.01977
0
0
0

97.903

PV2
9.374707
8.690473
7.980367
7.266508
72.31799
0
0
0

105.630

5.2
2 Independent goals and 10 Projects
Total Annual Budget
$5,000,000
Table 5.2
Description
Cost ($1000000)
1- Concrete, 2 lanes
2
Road
2- Concrete, 4 lanes
3
between
1.5
Augen and 3- Asphalt, 2 lanes
Burger
4- Asphalt, 4 lanes
2.2
5- Repair existing
0.5
1.5
Bridge at cay 6- Add Lane
road
7- New Structure
2.5
8- Traffic lights
0.1
0.6
Traffic Control 9- Turn Lanes
in Downsberg 10- Underpass
1
Atmost one project can be selected for each major objectives.

The Bridge at Cay road is actually part of the road between Augen and Burger. Therefor
reasonable for the bridge to have fewer lanes than the road itself.

MAXIMIZE

Maximize NPV Or Profit:

4X1+ 5X2+3X3+ 4.3X4+X5+ 1.5X6+2.5X7+ 0.3X8+X9+ 2X10
2X1+ 3X2+1.5X3+ 2.2X4+.5X5+ 1.5X6+2.5X7+ 0.1X8+.6X9+ X10<=5
X1+ X2+X3+ X4 <=1
X5+ X6+X7 <=1
X8+ X9+X10 <=1
(X2+ X4 ) ( 1- X 6 -X7) = 0

If project 2 or 4 are carried out, either 6 or 7 must also

Using excel solver.

X1, X2, X3,X4,X5,X6,X7, X8,X9, X10= 0 or 1

( Binary)

Answer:

See above table for solution by excel solver.

Q. 5.7

Fishing Problem
10*2

10*4

10*8
Node vales: Tonnage of fish
Branch Values: Cash Flows

" 0" indicates no consumption as cash flo

"7" indicates 70 percent fishes extracted
"10" indicates population reaches to the
"20" indicates population doubles in next

Interest rate:
33%
Discount factor:
0.75188
Highest cash flow generating path from ends
( 28, 0, 0) & ( 14, 14, 0)
Value (V) = MAXIMUM ( 0+ 0.75188*28 , 14 + 0.75188*14)
MAX

21.05263 24.52631579 )

14, 14 , 0 path have maximum running PV.

Interest rate:
25%
Discount factor:
0.8
Highest cash flow generating path from ends
( 28, 0, 0) & ( 14, 14, 0)
Value (V) = MAXIMUM ( 0 + 0.8*28 , 14 + 0.8*14)
MAX

22.4

25.2 )

14, 14 , 0 path have maximum running PV.

So decision will remain same
Critical Values:
0 + dk, k+1 * 28 = 14 + dk, k+1* 14
dk, k+1* 14 = 14
dk, k+1= 1
Discount factor for another path
14 + d * 14 = 7 + d*7 + 7 * d2
7*d2 - 7*d -7 = 0
d2 - d -1 = 0
Discount factor
-1.6E-005
d=
1.618027
Interst rate =
61.80%

Answer

Using Excel Solver:

NPV ($1000) Optimal x- Values Cost ($1000000)
4000
0.000
0
5000
0.000
0
3000
0.000
0
4300
1.000
2.2
1000
0.000
0
1500
1.000
1.5
2500
0.000
0
300
0.000
0
1000
0.000
0
2000
1.000
1.000
Sum
4.7

ween Augen and Burger. Therefore it is not

road itself.

+.6X9+ X10<=5

rried out, either 6 or 7 must also be carried out.

es: Tonnage of fish

Values: Cash Flows

NPV
0
0
0
4300
0
1500
0
0
0
2000
7800

Goals

cates no consumption as cash flow

ates 70 percent fishes extracted from the pond as cash flow
cates population reaches to the initial level in next season
cates population doubles in next season if no fish is extracted from the pond.

28

28

14

Node values: Optimum "Running PV"

14
7
7

1
4
0

0
7
0