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
PRIN.OF CORPORATE FINANCE >BI<
- What makes for a good investment? Use the approximate yield formula or a financial calculator to rank the following investments according to their expected returns. Buy a stock for $30 a share, hold it for three years, and then sell it for $60 a share (the stock pays annual dividends of $2 a share). Buy a security for $40, hold it for two years, and then sell it for $100 (current income on this security is zero). Buy a one-year, 5 percent note for $1,000 (assume that the note has a $1,000 par value and that it will be held to maturity).arrow_forwardA government bond with a par value of R1000, maturing in 5 years, offers an annual coupon of 9.5%, and a yield to maturity of 11.5%. PART A: What is the current value of the bond? Give your answer in Rands (R) correct to TWO decimal places.R........ PART B: Use the table approach to determine the value on the right-hand side of the convexity calculation. That is, what is the sum of the discounted cash flows, multiplied by (t2 + t)?Provide your answer correct to TWO decimal places. Answer.......... PART C: Given your results above, what is the convexity of this bond?Give your answer, correct to TWO decimal places. Answer....... PART D: If this bond has a modified duration of 4 and yields increase by 200 basis points, the correction for convexity ((∆P/P) will forecast that the bond price will decrease by what percentage?Provide your answer, in percent (%), correct to TWO decimal places. Answer% ..........You do not have to indicate the negative with `–` or `() `, simply provide your…arrow_forwardAn Overview of Financial Management and the Financial Environment Differentiate between the following types of markets: physical asset vs. financial markets, spot vs. futures markets, money vs. capital markets, primary vs. secondary markets, and public vs. private markets the real risk free rate of interest is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium (MRP) is zero. What is the yield on a 2 year Treasury security? What is the yield on 3 year Treasury securities? If Apple Computer decided to issue additional common stock, and someone purchased 100 shares of this stock from Merrill Lynch, the underwriter, would this transaction be a primary market transaction or a secondary market transaction? Would it make a difference if the investor purchased previously outstanding Apple stock in the dealer market?arrow_forward
- 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
- Pfin (with Mindtap, 1 Term Printed Access Card) (...FinanceISBN:9780357033609Author:Randall Billingsley, Lawrence J. Gitman, Michael D. JoehnkPublisher:Cengage LearningIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning