nilla interest rate swap with a company named NeverDown. Under the terms of the swap, the hedge fund receives six-month LIBOR and pay 8 percent per annum on a principle of $100 million for five years. Payments are made every 6 months. Assume that the interest rates start to soar after two years and NeverDown defaults on the sixth payment date when the LIBOR rate is 10 percent for all maturities (with semi-

nilla interest rate swap with a company named NeverDown. Under the terms of the swap, the hedge fund receives six-month LIBOR and pay 8 percent per annum on a principle of $100 million for five years. Payments are made every 6 months. Assume that the interest rates start to soar after two years and NeverDown defaults on the sixth payment date when the LIBOR rate is 10 percent for all maturities (with semi-

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter6: Fixed-income Securities: Characteristics And Valuation

Section: Chapter Questions

Problem 4P

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A mutual fund plans to purchase $500,000 of 30-year Treasury bonds in four months. These bonds have a duration of 12 years and are priced at 96-08 (32nds). The mutual fund is concerned about interest rates changing over the next four months and is considering a hedge with T-bond futures contracts that mature in six months. The T-bond futures contracts are selling for 98-24 (32nds) and have a duration of 8.5 years. If interest rate changes in the spot market exactly match those in the futures market, what type of futures position should the mutual fund create? How many contracts should be used? If the implied rate on the deliverable bond in the futures market moves 12 percent more than the change in the discounted spot rate, how many futures contracts should be used to hedge the portfolio? What causes futures contracts to have a different price sensitivity than the assets in the spot markets?
A credit default swap requires a semi annual payment at the rate of 200 basis points per year. The principal is $1 billion and the credit default swap is settled in cash. A default occurs after four years and two months, and the calculation agent estimates that the price of the cheapest deliverable bond is 60% of its face value shortly after the default. List the cash flows and their timing for the seller of the credit default swap..
A) On the fixed income side, the fund has issued £500m 5 year bonds, semi-annual pay, floating rate notes with coupons equal to 180 day LIBOR plus 30 basis points. Now, one year later, the risk manager is worried that the interest rates might rise over rest of tenor of the issue. Hence, the firm decide to go long into a 3 year payer swaption with a fixed rate of 2.5%, semi-annual pay, with N.P of £500m. For simplicity, assume that swap and FRN have the same settlement dates. At the swap initiation, 180 day LIBOR is at 3% and 360 day LIBOR is at 3.5%. Required: Show the net settlement in 180 and 360 days? Show the firm the has effectively eliminated the uncertainty associated with FRN by entering into a swap?
Thermo-Tech Systems recently sold a $20 million bond issue with a 20-year maturity and a coupon rate of 7% compounded semiannually. The bond indenture contract requires Thermo-Tech to make equal payments at the end of every 6 months into a sinking fund, which should accumulate the full $20 million required to redeem the bonds at their maturity. (Round all values to nearest $). a. What should be the size of the sinking fund payments if the fund earns 4.5% compounded semiannually? b. How much will the fund earn in the sixth year?. How much will the fund increase in the 27th payment interval? d. What is the semiannual cost of the debt
The spot price of gold today is $1, 507 per troy ounce, and the futures price for a contract maturing in seven months is $1, 548 per troy ounce. If Golddy Plc puts on a futures hedge today and lifts the hedge after five months. a) Calculate the cost of carry for gold. b) If the spot price of gold in five months' time turns out to be $1,520. What will be the futures price five months from now? c) How much is the basis in five months' time?
You can enter into a forward contract for a bond with a maturity in one year months that pays a coupon payment of $25 every six months. The bond has a forward price of $930. The current zero coupon rate for 6 months is 4% annually and the zero coupon risk free rate for one year is 5% annually (assume continuous compounding). The current price of the bond is $943. Use the equilibrium forward price equation (F=Sert) adjusted for both coupon payments to see if an arbitrage opportunity exists. If arbitrage is possible, explain the arbitrage opportunity that exists and show how the profit can be earned – make sure to explain every step in detail in realizing the profit and establishing the arbitrage. If arbitrage is not possible, show how you know it is not possible. ANSWER IN TYPING OTHER WISE DOWNVOTE YOU
A bank has assets of $500,000,000 and equity of $40,000,000. The assets have an average duration of 5.5 years, and the liabilities have an average duration of 2.5 years. An 8-year fixed-rate T-bond with the same coupon as the fixed-rate on the swap has a duration of 6 years, and the duration of a floating-rate bond that reprices annually is one year. The bank wishes to hedge its balance sheet with swap contracts that have notional contracts of $100,000. What is the optimal number of swap contracts into which the bank should enter? 2,500 contracts. 2,760 contracts. 13,800 contracts. 3,200 contracts. None of the above.
You are considering investing in a security that matures in 10 yearswith a par value of $1,000. During the first five years, the securityhas an 8 percent coupon with quarterly payments (that is, you receive$20 a quarter for the first 20 quarters). During the remaining fiveyears the security has a 10 percent coupon with quarterly payments (thatis, you receive $25 a quarter for the second 20 quarters). After 10years (40 quarters) you receive the par value.Another 10-year bond has an 8 percent semiannual coupon (that is, thecoupon payment is $40 every six months). This bond is selling at itspar value, $1,000. This bond has the same risk as the security you arethinking of purchasing. Given this information, what should be theprice of the security you are considering purchasing?a. $ 898.65b. $1,060.72c. $1,037.61d. $ 943.22e. $1,145.89
An insurance company must make payments to a customer of $10 million in one year and $4 million in five years. The yield curve is flat at 10%.a. If it wants to fully fund and immunize its obligation to this customer with a single issue of a zero-coupon bond, what maturity bond must it purchase?b. What must be the face value and market value of that zero-coupon bond?
An investor has purchased a floating-rate security with a 5-year maturity. The coupon formula for the floater is 6-month LIBOR plus 170 basis points and the interest payments are made semi-annually. The floater is non-callable. At the time of purchase, 6-month LIBOR is 5.5%. The investor borrowed the funds to purchase the floater by issuing a 5-year note at par value with a fixed coupon rate of 6.8%. Suppose the 5-year swap rate is 5.3% and the frequency of the payments is semi-annual. 1) Ignoring credit risk, what is the risk that this investor faces? 2) Explain how the investor can enter into a 5-year interest rate swap (in which one party pays the swap rate in exchange for 6-month LIBOR) to offset this risk and show the annual income spread the investor can lock-in using the swap contract.
Suppose that a bank has agreed to the following terms of an interest rate swap:- The notional principal is CAD 300 million and the remaining life of the swap is 11 months.- The bank pays 8% per annum, and receives three-month LIBOR.- Payments are exchanged every three months.- The swap (fixed) rate is 11% per annum for all maturities.- The three-month LIBOR rate a month ago was 12.5% per annum. All rates are compounded quarterly. Estimate the value of the swap using a) a bond-price valuation method, and b) a FRAs-based method?
Assume the current Treasury yield curve shows that the spot rates for six months, one year, and one and a half years are 1%, 1.1%, and 1.3%, all quoted as semiannually compounded APRs. What is the price of a $1,000 par, 4% coupon bond maturing in one and a half years (the next coupon is exactly six months from now)?