FUND CORP FIN+CONNECTPLUS(LL) >CUSTOM<
FUND CORP FIN+CONNECTPLUS(LL) >CUSTOM<
11th Edition
ISBN: 9781259699481
Author: Ross
Publisher: MCG CUSTOM
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Chapter 23, Problem 8CRCT
Summary Introduction

To discuss: Hedging strategies that a company might use when interest rates are expected to increase the next year.

Introduction:

Hedging interest rate risk is significant to an organization when issuing bonds. The rise of an interest rate will augment the coupon payment of the company. Mostly, the firms are using derivative instruments such as futures contracts and options contracts to hedge the interest rate risk of the company.

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Mf2. Suppose in Month 1 the yield on ten-year bonds issued by the government in a country was 1.8% (also the coupon rate). In the following Month 2, the yield was 2.3%. Predict the effect of these changes in yield on the price of the ten-year government bonds, assume a face value, 1000. You will need to calculate the duration, modified duration, convexity and clearly explain your results.
D3) The value of a derivative that pays off $100 after one year if a company has defaulted during the year is $5. The value of a derivative that pays off $100 after one year if a company has not defaulted is $97. (a) What is the risk-free rate? (b) What is the risk-neutral probability of default?
D6) Since funds must keep flowing for a country to remain economically viable, briefly explain the role of financial institutions and financial markets in ensuring a regular funds flow between demanders and suppliers of funds. (80-100 words) A 15-year annual coupon bond trades for $1,200 in the market. If the market interest rate is 4%, what is the bond’s coupon rate?
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