Question 1

Using the spreadsheet "Term Structure Template.xlsx" please complete the following exercises.

1. Calculate the prices for the first two bonds (.5 and 1 yr to maturity)

2. Calculate the spot rates, discount factors, and forward rates for the curve. State these rates both on a semi-annual and a BEY basis.

3. Use the spot rates to price a 6-year semi-annual pay 6% coupon bond. (Note: You will want to do this in an extra column in your excel spreadsheet).

4. Use the spot rates to price a 5-year semi-annual pay 9% coupon bond. (Note: You will want to do this in an extra column in your excel spreadsheet).

5. Use the spot rates to price a 4-year 7% semi-annual pay coupon bond. (Note: You will want to do this in an extra column in your excel spreadsheet).

Problem:

Assume that you wish to take a bet on the yield spread between two bonds: a 10-year corporate bond rated BB and a 10-year Treasury bond. Information about both bonds follows:

bond                 10 year Treasury bond    10 year BB corporate

Maturity            10 years                          10 years 

Coupon rate     5%                                   7%                                                         

YTM                   5.5%                                7.5%

 Current price    $96.193                           $96.526             

DV01                 $0.0744                           $0.0680 

Assume that you believe the economy is going to get much worse in the future, and you wish to make your bet based on this premise. Also assume that you will buy 1000 units of the bond that you are going to hold "long." Finally, ignore margin requirements, interest on cash proceeds, and any intervening coupon payments of the long and short bonds. Answer the following questions in a Word document:

1. Are you betting that rates are going to converge or diverge? Why?

2. Which bond will you buy and which bond will you short-sell?

3. What is the DV01 ratio? Round to exactly 4 decimal places.

4. Using the DV01 ratio, calculate the number of units of the bond you will short-sell.

5. State your initial balance sheet assuming you implement the trade. Assume that you come up with the cash to fund the long position out of your pocket. Be sure to clearly label each column and describe each entry. Also be sure to include the totals.

6.Assume that in 1 month, the following is the information about the two bonds

                      10 year Treasury bond     10 year BB corporate bond

Maturity          10 years                           10 years  

Coupon rate   5%                                     7% 

YTM                 6%                                     7% 

Current price  $92.561                              $100 7.

7.Restate your balance sheet using the above information. Be sure to clearly label each column and describe each entry. Also be sure to include the totals.

8. What is your gain or loss on equity in dollars?

9. What is your percentage gain or loss on equity as a holding period return?

Attachment:- Assignment-1--TERM-STRUCTURE-.rar