Problem

(a) The yields to maturity on five zero-coupon bonds are given below:

                   Years to Maturity                 Yield (%)
                                1                                  12.0
                                2                                  14.0
                                3                                  15.0
                                4                                  15.5
                                5                                  15.7
Required:

(i) What is the implied forward rate of interest for the third year?

(ii) What rate of interest would you receive if you bought a bond at the beginning of the second year and sold it at the beginning of the fourth
year?

(b) Most futures contracts have fairly short lives, usually less than 18 months. Why are there not futures contracts with longer lives?

(c) On January 29, 1987, you could buy a March 1987 silver contract for $5.610 per ounce and at the same time sell a March 1988 contract for $6.008 at ounce.

Required:

(i) What would you have done if you had taken these positions?

(ii) If the annual riskless rate of interest were 8%, would the position be profitable? Give reasons?

Part B:

When deciding on a technique to hedge a risk associated with a financial position, a number of aspects have to be taken into account. Explain clearly five of the aspects that need to be considered?