INVESTMENTS
11th Edition
ISBN: 9781260689488
Author: Bodie
Publisher: MCG
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Chapter 22, Problem 4CP
a.
Summary Introduction
To evaluate: Whether the investor should purchase or sell the forward contract in order to protect the value of the bond from rising interest rate during the holding period.
Introduction:
Forward contract: It is supposed to be a contract made between two parties which is customized according to the needs of the parties. The contract is regarding purchase or sale of an asset at a specific price agreed by the two parties. This transaction will take place on a future date.
b.
Summary Introduction
To determine: The value of forward contract for the investor at the maturity period assuming Mr. VanHusen’s
Introduction:
Holding period: It is supposed to be the time for which the investment is held by the investor. In other words, it can be the period of the investment between the activity of purchase and sale of a security.
c.
Summary Introduction
To determine: The change in the value of combined portfolio six months after the contract initiation.
Introduction:
Portfolio: In finance, a portfolio can be defined as a range of investments that are held by a person or an organization.
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Maria VanHusen, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Star Hospital Pension Plan’s bond portfolio against the possibility of rising interest rates. VanHusen prepares the following example to illustrate how such protec-tion would work:∙ A 10-year bond with a face value of $1,000 is issued today at par value. The bond pays an annual coupon.∙ An investor intends to buy this bond today and sell it in 6 months.∙ The 6-month risk-free interest rate today is 5% (annualized).∙ A 6-month forward contract on this bond is available, with a forward price of $1,024.70.∙ In 6 months, the price of the bond, including accrued interest, is forecast to fall to $978.40 as a result of a rise in interest rates.a. Should the investor buy or sell the forward contract to protect the value of the bond against rising interest rates during the holding period?b. Calculate the value of the forward contract for the investor at the maturity of…
The Chief Financial Officer of a company would like to raise money for new equipment by floating a new bond issue. The CFO would like to receive $1000 (full face value) for each of the bonds she sells. After collecting the below bond market data, and if the bonds carry a rating of A and have a term of 10 years, what coupon rate should be included in the bond contract? Assume an annual coupon payment.
Security& Rating Maturity Face Coupon Price
Treasury 1 $ 1,000 0.00% $ 965.00
Treasury 3 $ 1,000 1.90% $ 939.06
Treasury 5 $ 1,000 4.30% $ 932.42
Treasury 10 $ 1,000 6.80% $ 1,007.12
Treasury 15 $ 1,000 6.60% $ 908.25
CorpA A 5 $ 1,000 8.10% $ 990.00
CorpB BB 10 $ 1,000 7.90% $ 859.88
CorpC AA 15 $ 1,000 7.00% $ 660.00
You wish to create a synthetic forward rate agreement in which you would lock in a return between 150 and 310 days. The price of a 150-day zero coupon bond is 0.9823 and the price of 310-day zero coupon bond is 0.9634. Which one of the following method is the correct method to create the synthetic FRA? Explain. [Professor’s note: This is a challenging questions].
A) Borrow one 150-day bond and invest in 1.02 of the 310-day bondsB) Borrow two 150-day bonds and invest in 0.98 of the 310-day bonds C) Lend one of the 150-day bonds and borrow 1.02 of the 310-day bonds D) Lend two of the 150-day bonds and borrow 0.98 of the 310-day bonds
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