a.
To compute: The duration of securities when the rate of interest is 8%.
a.
Explanation of Solution
The formula to calculate duration of securities is as follows:
The calculation of duration of securities is as follows:
Security A:
Security B:
Security C:
b.
To compute: The mixture of B and C will hedge this investment against changes in interest rates.
b.
Explanation of Solution
The formula to calculate mixture of B and C is as follows:
The computation is as follows:
So that the following positions will protect the investment:
c.
To discuss: The manner in which the person X will hedge.
c.
Explanation of Solution
So that the succeeding positions will protect the investment.
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Chapter 26 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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- You follow the equity index HSI using an index fund in Hong Kong. You have signed aninterest rate swap to exchange the capital gains (losses) from your portfolio, against a sequenceof cash flows based on 3-month Libor plus 25 bp. The cash flows are exchanged every 90 days.All cash payments occur in Hong Kong dollars.The notional principal is 1 million.a. Draw the cash flow diagram for the first year.b. Let It be the value of the index at time t. Suppose you have the following data:I0 = 23,850 I1 = 24,000 L0 = 4.5%What is the net amount exchanged at period 1?arrow_forwardBOND VALUATION An investor has two bonds in his portfolio that have a face value of$1,000 and pay an 11% annual coupon. Bond L matures in 12 years, while Bond S maturesin 1 year.a. What will the value of each bond be if the going interest rate is 6%, 8%, and 12%?Assume that only one more interest payment is to be made on Bond S at its maturityand that 12 more payments are to be made on Bond L.b. Why does the longer-term bond’s price vary more than the price of the shorter-termbond when interest rates change?arrow_forwardAn investor has $633,000 to invest in bonds. Bond A yields an average of 8% and the bond B yields 5%. The investor requires that at least 3 times as much money be invested in bond A as in bond B. You must invest in these bonds to maximize his return. This can be set up as a linear programming problem. Introduce the decision variables: ?=dollars invested in bond A ?=dollars invested in bond B Compute ?+? $ ________. Round to the nearest cent.arrow_forward
- The promised cash flows of three securities are listed below. If the cash flows are risk-free, and the risk-free interest rate is 5.0%, determine the no-arbitrage price of each security before the first cash flow is paid. Security Cash Flow Today ($) Cash Flow in One Year ($) A 800 800 B 0 1600 C 1,600 0 The no-arbitrage price of security A is how much? ? (Round to the nearest cent.) The no-arbitrage price of security B is how much? ? (Round to the nearest cent.) The no-arbitrage price of security C is how much? ? (Round to the nearest cent.)arrow_forwardInterest rates on 4-year Treasury securities are currently 6.7%,while 6-year Treasury securities yield 7.25%. If the pure expectations theory is correct, whatdoes the market believe that 2-year securities will be yielding 4 years from now? Calculatethe yield using a geometric average.arrow_forwardConsider two securities that pay risk-free cash flows over the next two years and that have the current market prices shown here: Security Price Today Cash Flow in One Year Cash Flow in Two Years B1 $192 $200 0 B2 $176 0 $200 What is the no-arbitrage price of a security that pays cash flows of $200 in one year and $200 in two years? What is the no-arbitrage price of a security that pays cash flows of $200 in one year and $1600 in two years? Suppose a security with cash flows of $100 in one year and $200 in two years is trading for a price of $260. What arbitrage opportunity is available?arrow_forward
- one-year treasrury securities yield 5%. the market anticipates that 1 year from now, 1-year treasury securities will yield 6%. if the pure expectations theory is correct, what is the yield today for the 2-year security?arrow_forwardThe yield to maturity (YTM) on 1-year zero-coupon bonds is 5%, and the YTM on 2-year zeros is 6%. The YTM on 2-year-maturity coupon bonds with coupon rates of 12% (paid annually) is 5.8%.a. What arbitrage opportunity is available for an investment banking firm?b. What is the profit on the activity?arrow_forwardA two-year maturity floater. Assume annual coupon payment and $1,000 par. Its discount rate is Libor + 2%. The discount rate for fixed cash flows is 2% a. What is the price of this floater if the coupon is Libor + 2%? b. What is the price of this floater if the coupon is Libor + 1%?arrow_forward
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