Reference no: EM133140132

Questions -

Q1. Ricky bought a 20-year 10% coupon bond at a yield to maturity of 8% today. The bond pays coupon interest twice a year and the first coupon payment will be made six month from today. Ricky plans to hold the bond until maturity and re-invest all coupons at the future interest rates. Future interest rates are expected to be: 10% (per annum, compounded semi-annually) between the beginning of year 1 to end of year 10; and 5% (per annum, compounded semi-annually) between the beginning of year 11 to end of year 20.

a. Calculate the price of the bond in percentage of its par value.

b. Calculate the total future value of Ricky's bond investment at the end of the 20-year holding period.

c. Compute the total return rate of the bond investment.

Q2. A portfolio manager has a mandate to maintain the portfolio duration at 6 - 7 years. Currently, in his portfolio, half of them is investing in Bond A and half in Bond B.

a. He has a view that interest rate will go down. How will he adjust the portfolio to capture this view? (That is, to swap x% of Bond A to Bond B or vice versa.)

b. i) One year passed by, should the portfolio manager would like to maintain the portfolioduration and assuming the market interest rates have come down and stabilized, what should he do? Why?

ii) One year passed by, should the portfolio manager believe that the bond rally has come to an end and interest rates will go up instead. What do you think he will do? Explain.

Q3. Consider a 5 year bond with annual coupon 6%.

a. What is the price of the bond should the required yield is 6% (compounding annually)? Show the formula used.

b. Estimate the price of the bond should the required yield be decreased by 1% to 5% using duration.

c. Without doing the calculation, should the actual price of the bond with yield 5% be higher or lower than the answer computed in (b). Please draw the graph to illustrate your answer. How will you explain the difference?