Name: 李耀倫
Student No: 0809853A-B011-2996
Fixed Income Securities 1

7. A pension fund manager knows that the following liabilities must be satisfied: Years from Now Liability (in millions)
|Years From Now |Liability (in millions) | |1 |$2.0 | |2 |$3.0 | |3 |$5.4 | |4 |$5.8 |

Suppose that the pension fund manager wants to invest a sum of money that will satisfy this liability stream. Assuming that any amount that can be invested today can earn an annual interest rate of 7.6%, how much must be invested today to satisfy this liability stream?

Name: 李耀倫 Student No: 0809853A-B011-2996 Fixed Income Securities 1

8. Calculate for each of the following bonds the price per $1,000 of par value assuming semiannual coupon payments and explain the price-yield relationship based on your results.

|Bond |Coupon Rate |Years to Maturity |Required yield | |A...

...FINA0804/2323 FixedIncomeSecurities
Dr. Huiyan Qiu
Homework Assignment #1
Due: February 17, Monday, drop in TA’s box by 6PM
Unless explicitly specified, bond pays coupon interest semi-annually.
1. (a) Provide the list of currently outstanding Government Bonds in Hong Kong.
Information should include at least the maturity date, the coupon rate, and the size of
each bond. (b) Describe the most recent Hong Kong Government Bond issuance under
the Institutional Bond Issuance Programme.
2.
The portfolio manager of a tax-exempt fund is considering investing $500,000 in a
zero-coupon debt instrument that pays an annual interest rate of 5.7% for four years.
At the end of four years, the portfolio manager plans to reinvest the proceeds for
three more years and expects that for the three-year period, an annual interest rate
of 7.2% can be earned. What is the expected future value of this investment?
Assume all rates are compounded annually.
(b) Suppose that the portfolio manager in the above question has the opportunity to
invest the $500,000 for seven years in a zero-coupon debt obligation that promises
to pay an annual interest rate of 6.1%, compounded semiannually. Is this investment
alternative more attractive than the one above?
(a)
3. Consider a bond with $1,000 par value and coupon rate of 5%. The bond has 2.15 years
remaining until maturity. Suppose the discount rate is 6.5%. Calculate the accrued...

...ANSWERS TO QUESTIONS FOR CHAPTER 1
(Questions are in bold print followed by answers.)
2. What is meant by a mortgage-backed security?
A mortgage-backed security is a security backed by one or more mortgage loans. Like a bond that is callable, a mortgage-backed security allows the investor to grant the borrower an option.
4. What is the cash flow of a 10-year bond that pays coupon interest semiannually, has a coupon rate of 7%, and has a par value of $100,000?
The principal or par value of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date. The coupon rate multiplied by the principal of the bond provides the dollar amount of the coupon (or annual amount of the interest payment). A 10-year bond with a 7% annual coupon rate and a principal of $100,000 will pay semiannual interest of (0.07/2)($100,000) = $3,500 for 10(2) = 20 periods. Thus, the cash flow is $3,500. In addition to this periodic cash, the issuer of the bond is obligated to pay back the principal of $100,000 at the time the last $3,500 is paid.
6. Give three reasons why the maturity of a bond is important.
There are three reasons why the term to maturity of a bond is important. First, the term to maturity indicates the time period over which the holder of the bond can expect to receive the coupon payments and the number of years before the principal will be paid in full. Second, the term to...

...points (or 1.30%).
(c) Suppose that on coupon reset date that 1-month LIBOR is 2.4%. What will the coupon rate be for the period?
The coupon reset formula is: 1-month LIBOR + 130 basis points. So, if 1-month LIBOR on the coupon reset date is 2.4%, the coupon rate is reset for that period at 2.40% + 1.30% = 3.70%..
11. Answer the below questions.
(a) What is the advantage of a call feature for an issuer?
Inclusion of a call feature benefits bond issuers by allowing them to replace an old bond issue with a lower-interest cost issue if interest rates in the market decline. A call provision effectively allows the issuer to alter the maturity of a bond. The right to call an obligation is included in most loans and therefore in all securities created from such loans. This is because the borrower typically has the right to pay off a loan at any time, in whole or in part, prior to the stated maturity date of the loan.
(b) What are the disadvantages of a call feature for the bondholder?
From the bondholder’s perspective, there are three disadvantages to call provisions. First, the cash flow pattern of a callable bond is not known with certainty. Second, because the issuer will call the bonds when interest rates have dropped, the investor is exposed to reinvestment risk (i.e., the investor will have to reinvest the proceeds when the bond is called at relatively lower interest rates). Finally, the capital appreciation potential of a bond will be...

...3, 4, 12, 14, 15a, 15b, 16, 17, 21, 23, 24, 25
3. Who are the major types of issuers of bonds in the United States?
The major types of issuers of bonds in the United States are the United States Government and its agencies, municipal governments and corporations or Special Purpose Vehicles (SPV).
4. What is the cash flow of a 10-year bond that pays coupon interest semiannually, has a coupon rate of 7%, and has a par value of $ 100,000?
The periodic cash flow is $3,500 as well as the principal pay back of $100,000 coinciding with the last payment of $3,500.
12. a. What is meant by an amortizing security?
An amortizing security is created from loans that have an amortization schedule. These securities will then have a schedule of periodic principal repayments.
12. b. Why is the maturity of an amortizing security not a useful measure?
The stated maturity of such securities only identifies when the final principal payment will be made. The repayment of the principal is being made over time.
13. What is a bond with an embedded option?
A provision included in the indenture of a bond that gives either the bondholder and/or issuer an option to take some action against the other party.
14. What does the call provision for a bond entitle the issuer to do?
A call provision grants the issuer the right to retire the debt, fully or partially, before the scheduled maturity date.
15. a. What is the...

...FixedIncomeSecurities
Chapter 2 Basics of FixedIncomeSecurities
Problem Set
(light version of the exercises in the text)
Q3.
You are given the following data on diﬀerent rates with the same maturity (1.5
years), but quoted on a diﬀerent basis and diﬀerent compounding frequencies:
• Continuously compounded rate: 2.00% annualized rate
• Continuously compounded return on maturity: 3.00%
• Annually compounded rate: 2.10% annualized rate
• Semi-annually compounded rate: 2.01% annualized rate
You want to ﬁnd an arbitrage opportunity among these rates. Is there any one that
seems to be mispriced?
Answer: This exercise tests your knowledge of dealing with interest rates with diﬀerent
compounding frequency.
Given the interest rates, we can compute the discount factors correspondingly.
From continuously compounded rate: 2.00% annualized rate:
Z (0, 1.5) = exp (−r (0, 1.5) × (T − t))
= exp (−0.02 × 1.5) = 0.970 45
From continuously compounded return on maturity: 3.00% (we did not cover this in
class, but it means the unannualized interest rate)
Z (0, 1.5) = exp (−0.03) = 0.970 45
From annually compounded rate: 2.10% annualized rate:
Z (0, 1.5) =
1
(T −t)
(1 + r1 (0, 1.5))
=
1
= 0.969 307 08
(1 + 0.021)1.5
From semi-annually compounded rate: 2.01% annualized rate,
1
Z (0, 1.5) =
1+
r2 (0,1.5)
2
2×(T −t)
1
=
1+
0.0201 2×1.5
2
= 0.970...

...interest rate.
Question 2
a)
The inflation-adjusted par value of $ 100 equals $ 108 (100 × 1.08) on April 15.
The coupon payment is 108 ×(3.88%)/2 = $2.0952
Since we only can invest $100 in security 1 and the price of security is 107.13, our investment occupied 93.34% of security 1. We will receive 93.34% × $2.0952 = $1.9557 on April 15.
b)
Firstly, On April 15, the inflation-adjusted par value of bond 3 is $100.031 (100×1.0031). The coupon payment is $100.031×(3.38%)/2 = $1.6905. At the next six months, the inflation turns out to be negative 1%, so the inflation-adjusted par value equals to $100.031 × (1-0.01/2) = $99.53. Therefore, the coupon payment is $99.53×(3.38%)/2=$1.6821.
If it is zero inflation in next six month, the coupon will still pay $1.6905 which base on the adjusted principal of $100.031. Thus, the cash from the coupon in the deflation scenario will be lower compared the case in which there would be zero inflation.
c)
Six months later:
Security Coupon (%) Inflation-adjusted principal Coupon Payment
1 3.88 100×1.08×(1-0.005)=107.46 2.0847
2 3.63 100×1.09×(1-0.005)=108.455 1.9685
3 3.38 99.53 1.6821.
If we investing $100 in each security, we will receive the following amount of coupon in six months later:
Security Proportion of the security Coupon Payment
1 0.9335 0.9335×$2.0847=$1.9461
2 0.9750 0.9750×$1.9685=$1.9193
3...

...FIXEDINCOMESECURITIESFixedIncome can be a very important investment class by which one can diversify his/her portfolio to reduce risk.
Putting all your money into equities (read more about equity investment) can give you more returns but it does carry high risk as well. Diversification is a basic concept of financial planning and fixedincome products come in handy to help us achieve this objective.
Let us see what are the different types of fixedincomesecurities and how they help savvy investors who chose to put money in them.
How they work
When you buy a fixedincome instrument, you are essentially lending money to a borrower. Money does not come free so you would expect something in return from the borrower.
The borrower issues out interest payments to you which could be paid either annually, quarterly, monthly or any other frequency that is pre-decided. These interest payments are called coupons. Since these coupons are fixed in nature, these instruments are called fixedincome instruments.
The borrower also promises to return the money he borrowed from you. So, apart from a consistent income in the form of coupons, you also get your principal back.
Such products are available for different maturities and credit ratings. They are...

...Case IV: Arbitrage in the Government Bond Market
Fixedincome management (EBC4058)
Tutor: Micheal Viehs Coordinator: Thomas Post Group C: de Vivo Paolo 6057152 Bing-Jun Zhu 6030493 Honglei Zhao 6051963 04/03/2013
INDEX
I INTRODUCTION II BOND MARKET – A snapshot III TWO SYNTHETIC BONDS BUILD THE TWO SYNTHETIC BONDS PRICE OF THE SYNTHETIC BONDS IV HOW TO EXPLOIT THE ARBITRAGE OPPORTUNITY SPECULATING ON POSSIBLE REASONS V THE ADVANTAGES OF CALLABLE BONDS VI CONCLUSIONS VII PROBLEM SET Derive the arbitrage-free short rate tree using the Black-DermanToy model Value the bond using the given yields Value the bond using the short rates Value callable bonds Value call option VIII REFERENCES IX APPENDIX
1
I INTRODUCTION In this case we are going to investigate further arbitrage opportunities among Government Bond (and Bond-related) market. From a theoretical standpoint, this market should be extremely efficient due to the extremely large number of contracts negotiated and the presence of several different players (from private people to hedge funds). However, as underlined by our case, on 7 January 1991 a particular bond (8.25 May 00-05) seemed to be underpriced, providing room for arbitrage opportunities. In this paper, we are going to analyze how to exploit this arbitrage opportunity by replication. First, we will focus briefly on the features of US bond market. Second, we will build two synthetic securities...

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