Question 1 2
Question 2 2
Question 3 3
Question 4 3
Question 5 3
Question 6 4
Question 7 4
Question 1
We are given two bonds with the same interest rate of 5%, and no one of bonds has an embedded option so they will not be exercised prior to the date of maturity. Moreover, both bonds are traded in one market and they have identical yield, therefore it is irrelevant factor. However, two bonds have different term of maturity: bond A matures in 15 years, while bond B matures only in 10 years. Fabozzi and Mann (Fabozzi & Mann, 2005) stated that the price volatility of the bond is closely related with its maturity term. Market rates of bonds will fluctuate more depending on the longevity of the maturity term of the underlying bond. Therefore, we can conclude that, in ceteris paribus condition except interest rate changes, the bond with a longer maturity period will have higher price volatility. To explain the reason why the bond A has higher price volatility we can use the percentage price change approximation using duration relationship. This formula consists of duration (maturity term), percentage change in yield (we have similar yields so this is irrelevant) and hundred basis points which is irrelevant in our condition. Since we took out two factors out of the formula, everything we left with is the answer:
Question 2
Using the same formula from the question one, we can make an assumption that the approximate percentage price change (using 100 basis points) first is equal to the following:
from this:
Now we can calculate that in case of 100 basis points percentage change in price is equal to 5%, in case of 50 basis points it is 2.5%, when 25 basis points it is 1.25% and when it is 10 basis points price change is equal to 0.5%. Next step is to work out change in dollar terms:
Question 3
First of all, the asset-backed security usually consists of many underlying assets pool, which means risk of ABS is broadly diversified. This kind well
References: Daniel, J., n.d. Street directory. [Online] Available at: http://www.streetdirectory.com/travel_guide/183448/finance/the_role_of_collateral_manager_in_trade_finance.html [Accessed 24 October 2014]. Fabozzi, F. J. & Mann, S. V., 2005. THE HANDBOOK OF FIXED INCOME ANALYSIS. 7 ed. United States: McGraw-Hill. Appendix Table 1 Table 2 Table 3