Essay on Ted Spread in Financial Crisis

1331 Words May 25th, 2012 6 Pages
Fixed Income Securities
Ted Spread and Swap Spread in a Financial Crisis
Discussion Questions
Due April 12, 2012

Please complete these questions in groups of 2, to hand in. The grade is calculated as part of your participation grade, so participation, as with the last case, can improve your score substantially, even if your calculations aren’t all perfect!

Should Albert Mills do this trade? Back up your answer with the following analyses:

1. Write out the initial transaction and cash flows for the trade based on entering the swap, purchasing the Treasury bond, and borrowing using the repurchase agreement. Assume $1 billion notional principal for the swap and $1 billion face value for the Treasury bond. You may be very
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Off course, if we think about only these numbers it seemed that TKC is receiving more than it pays but this not exactly true since TKC paid for the bonds more than it is going to get after the 38 years (premium bond = coupon>YTM plus TKC’ initial investment of $21 million.

2. Estimate the unrealized gain/loss on this trade as of November 19 (two weeks after the initial transaction date). Assume the following: repo rate stays at 0.15% for the full two week period with overnight rolling over of the loan (3 days on the weekend), the fixed swap rate is at 4.0%, the YTM on the Treasury is 4.2%. The Treasury will have an interest payment on November 15, so be sure to take this into account. The swap will not have a payment (either fixed or floating), but do account for the accrued interest on both sides of the trade, as well as the accrued interest on the Treasury bond (Treasury uses actual/actual day count, as you know). The floating piece of the swap uses actual/360 day count (stated in the case). The fixed piece of the swap uses actual/actual day count to calculate interest. Use DV01 measures to estimate the change in value of the swap and the bond. For the repo, assume actual/360 day count to calculate interest paid (interest is paid daily or on Monday in the case of a weekend).

a. Does this transaction generate a gain or a loss?
The transaction generates

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