Basic

bond pricing
1. Whatpriceshouldbeplacedonanew5year5%governmentbond(assuming biannualcoupons)toprovideayieldof6%? 2. Supposethebondinthepreviousquestionisissuedat98.Whatisitsyield? 3. Whatwillhappentothepriceofthisbondafter3months,assumingnochange inyield? 4. Supposethebondtradesatparafter3months.Whatistheimpliedyield? 5. On1January1996,Merckissueda30yearbondwithacouponrateof6.3% (MRK.GA). a. Giventhecurrentyield,whatistheinvoice(dirty)priceofthisbond today? b. Drawthepriceyieldcurveofthisbond.Estimateitsslope. c. Whatisthebondsduration? d. Calculatethepricevalueofabasispoint(PV01). e. Usethistoestimatetheimpactofa20basispointincreaseininterest rates. f. Calculatethepreciseimpactandcomparewithyourestimate.

6. Whatisconvexityofabond?Howwouldyoucalculateit?Estimatetheconvexity oftheMerckbond. 7. SupposetheMerck6.3%2026bondisquotedat$114.Whatistheimpliedyield? 8. SupposethatMerckbondwerecallableon1January2016at$105.Whatisthe yieldtocall? 9. Comparetheyieldofanew10year9.125%governmentEurobondsellingfor $993.33withthatofa10year9%U.S.Treasurysellingfor$990.31.Whichoffers thehigheryield,assumingthereisnoexchangeraterisk? 10. Atwhatpricewouldanew10yearzerocouponbond(nominalvalue100) provideayieldof5%?Supposeitisofferedat65.00.Whatistheimpliedyield? 11. Whatisthepriceof3month(91days)TBillissuedat5%?

12. The worksheet Coupon contains a term structure of interest rates for varying maturities ( = spot rates = yields of zero-coupon bonds) estimated by NSE using traded government securities. a. Graph the term structure. What do you observe? b. You have been asked to design a new 5-year semi-annual bond issue for your company. You observe that your companys existing bonds trade at a yield 50 basis points above government bonds of equivalent maturity. What coupon rate would you set to enable the bond to be issued at par? c. What is the duration of this bond? 13. Suppose you work for a large bank. Your client requires seeks to agree a oneyear loan to finance a major outlay in two years time. What interest rate would you quote? Use the term structure in the worksheet Coupon, ignoring any risk premium. 14. What rate would you quote for a 6-month loan starting in two years time? Is your answer consistent with that to the previous question?

Interest rate swaps

1. To calculate forwards from the money market rates Interpolate the missing spot rate (e.g. 9 months). Calculate discount factors from the money market rates. Infer forward rates from the discount factors. 2. To calculate discount factors from the future prices Calculate the implied forward rates. the term of each future contract. the period discount factor for the term of each contract. b. Using the money market data, calculate the discount factor to the maturity of the first futures contract. This is known as the cash-to-first-futures (CTTF) rate. c. Multiply the period discount factors cumulatively, to infer the total discount factor to discount to time zero. 3. On 4 February 2008, a company wants to buy a $100 million 3/6 forward rate agreement (FRA) from a bank. What is the appropriate fixed rate for such an FRA? How could the bank hedge this contract using futures? Determine the performance of the hedge if all rates increase 10 basis points. 4. Price the following swap Notional principal of $100 million 1-year maturity, starting 6 February 2008 To receive fixed r annual Actual/360 To pay 3-month Libor quarterly Use money market discount rates. 5. How would you hedge the swap in the previous question? 6. There is an inconsistency in using interest rates from the futures market to price and hedge the swap, while using cash rates for discounting. Revalue the swap using discount factors inferred from the LIBOR fixings (copy previous worksheet and rename Swap1m).

7. This methodology is very efficient in this case in which cash flows are quarterly. A more general approach, known as using continuously compounded interpolation, is frequently applied. To revalue the swap using this more general methodology (copy previous worksheet and rename Swap1g): Compute discount factors for the contract maturity dates. Compute equivalent spot rates assuming continuous compounding. Interpolate the spot rates for the dates of the LIBOR fixings. Use the spot rates to compute discount factors assuming continuous compounding. Value the swap using these discount factors.

8. Make a copy of Swap1m and rename it Hedge. For each futures contract in turn, calculate the impact on the value of the swap (given that the rate has already been determined) of a one basis point decrease in the futures price , i.e. the present value of a basis point (PV01). This is sometimes known as blipping the curve. Use these computations to design an appropriate hedge using Eurodollar futures. Compare with the hedge computed in a previous question. 9. Calculate the effectiveness of the hedge for parallel shifts in futures prices (-100 to +100 basis points). Graph the results. What do you observe? 10. Suppose you know the swap rate for a one-year swap, how can you infer the 1-year discount factor and the spot rate? 11. The template Swap2 details the cash flows for a two-year swap. However, the 6th February 2010 was a Saturday. Make the appropriate adjustment and price the swap. 12. Suppose you know the swap rate for a two-year swap, how can you infer the two-year discount factor? 13. Generalize the preceding exercise to develop an algorithm for inferring discount factors from swap rates. 14. Using the data in worksheet Bootstrapping, construct a discount function to the date of settlement. Compute the appropriate rates (money market, futures or swaps) for the given dates, interpolating where necessary. Compute discount factors for the first year from the money market. Compute discount factors for 6, 9 and 12 months from the futures market. Compute annual discount rates from the swap rates. Disregard the issue of holidays and weekends. 15. Convert the discount factors to continuously-compounded spot rates and plot the resulting interest rate curves.