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C323 - Risk Application - Question Answer

   

Added on  2020-03-01

6 Pages1477 Words110 Views
Running Head: RISK APPLICATION 1Risk ApplicationNameUniversity25th August 2017

RISK APLICATION 2You buy a three-year coupon-paying bond with a face value of 100 that pays a 5% annualcoupon at a time when the one-year zero-coupon yield, two-year zero-coupon yield, and three-year zero-coupon yield are equal to 2.0%, 3.0%, and 4.0%, respectively. 1)Under the assumption that the next coupon will be paid in exactly one year, what is theprice of the bond, its yield-to-maturity and its duration? Is the bond trading at par, at apremium or at a discount, why? SolutionN=3;i=2%,3%,4%;Pmt=100∗0.05=5FV=100Priceofbond=c×F×1−(1+r)−tr+F(1+r)tPriceofbond=5%×$100×1(1+0.03)+5%×$100×1(1+0.04)2+(5%×$100+100)×1(1+0.04)3=$102.8218YTM=(102.8218100)1/3−1=0.9319%This a premium bond since the bond price is higher than the bond'spar value2)Just after buying the bond, the zero-coupon yield curve moves up and stays unchangedfor 2 years; more specifically, the one-year zero-coupon yield, two-year zero-couponyield and three-year zero-coupon yield increase to 4.0%, 5.0%, and 6.0%, respectively.Calculate the relative change in the bond price and compare it to the relative changeobtained from the bond duration. How do you explain the difference? Solution

RISK APLICATION 3N=3;i=4%,5%,6%;Pmt=100∗0.05=5FV=100Priceofbond=c×F×1−(1+r)−tr+F(1+r)tPriceofbond=5%×$100×1(1+0.04)+5%×$100×1(1+0.05)2+(5%×$100+100)×1(1+0.06)3=$97.5029Relative change in bond price:102.8218−97.5029102.8218∗100%=5.173%3)You sell the bond after 2 years just after receiving the second coupon and after a decreasein the zero-coupon yield curve that pushes the one-year zero-coupon yield, two-yearzero-coupon yield and three-year zero-coupon yield down to 3.0, 4.0% and 5%,respectively. The new yield curve is expected to stay at that level for at least another year.What is your realized return on your investment? Why does it differ from the bond statedyield-to-maturity calculated in question 1?SolutionN=3;i=3%,4%,5%;Pmt=100∗0.05=5FV=100Priceofbond=c×F×1−(1+r)−tr+F(1+r)tPriceofbond=5%×$100×1(1+0.03)+5%×$100×1(1+0.04)2+(5%×$100+100)×1(1+0.05)3=$100.1801The realized return on investment is merely $0.1801; It differs to the YTM because of variation in interest.Q1:Which issues should investors consider when deciding whether to invest in a 130/30 fund? IsMartingale well suited to manage 130/30 funds successfully?ANSWER # 01:

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