Valuation using treasury spot rates, Financial Management

To understand how treasury spot rates are used to calculate the arbitrage-free value of the treasury security, we will take imaginary treasury spot rates (given in the third column of the Table No.6) to find the value of 7% 5-year treasury security. Sum of the present value (given in the last column of the Table No.1) is the arbitrage-free value for the 7% 5-year treasury security.

Table 1: Determination of the Arbitrage-Free Value of a 7% 5-Year Treasury Security

(a)

(b)

(c)

(d)

(e)

Period

Years

Cash Flow in Rs.

Spot Rate in %

PV in Rs.

  1

0.5

    3.5

2.7589

  3.4524

  2

1.0

    3.5

3.0356

  3.3961

  3

1.5

    3.5

3.2856

  3.3330

  4

2.0

   3.5

3.5563

  3.2617

  5

2.5

    3.5

3.8659

  3.1805

  6

3.0

    3.5

4.1068

  3.0982

  7

3.5

    3.5

4.3574

  3.0099

  8

4.0

    3.5

4.6012

  2.9177

  9

4.5

    3.5

4.9812

  2.8049

10

5.0

103.5

5.1225

80.3725

Arbitrage-Free Value of a 7%  5-Year  Treasury Security is =

108.8268                              

Posted Date: 9/10/2012 6:09:31 AM | Location : United States







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