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BBUS415
Investments II

1 Exam

October 2010
Dr. S. Hasan

Name: Last:.First: ....Student ID # .

Instructions: Each of the multiple choice questions are worth 2 points. Circle only one answer that you think is
correct. For the short questions, try not to exceed the given space. For problems, you need to show ALL your work.
Just a correct answer without work shown is not sufficient. Good luck.
17. The market values of a 10 year 9% coupon no-option bond at different yield levels are shown below. You can
assume any of these as the initial yield/value. Calculate the duration and the modified duration for this bond for a
150 basis point change in yield. Also, calculate the convexity adjustment to come up with an accurate estimate of
the change in bond value for a 150BP yield change.
Compare the adjusted estimate with the original one to
show that convexity adjustment works to better the estimate.
(15)
Yield
4.50%
4.75%
5.00%
5.25%
5.50%
5.75%

Value
1359.184
1335.215
1311.783
1288.875
1266.477
1244.577

Yield
6.00%
6.25%
6.50%
6.75%
7.00%
7.25%
7.50%

Value
1223.162
1202.221
1181.742
1161.713
1142.124
1122.964
1104.222

D = (1359.184 1104.222)/(2*1223.162*0.015) = 6.948

MD = 6.948/1.03 = 6.746
2
C = (1359.184 + 1104.222 2*1223.162)/( 2*1223.162*(0.015) = 31.0343
2
CA = 31.0343*100*(0.015) = 0.6983
Estimated change = (6.746% x 1.50)+ 0.6983% = 10.817% for a 150BP fall in YTM. Actual = 11.1205%
Estimated change = -(6.746% x 1.50)+ 0.6983% = -9.4207% for a 100BP rise in YTM. Actual = -9.724%

If you did not multiply by 1.50 to reflect a 150 basis point change than you got 12 out of 15, assuming everything
else was right. The reason you have to do that is because by definition, the modified duration is the estimated price
change for a 100 basis point in YTM. Since you have a 150 basis point change, hence the multiplying by 1.50.

19. Suppose that the price of a Treasury bill with 90 days to maturity and a $1 million face value is $980,000. What
is the yield on a bank discount basis?
(5)

a Treasury bill with 90 days to maturity, a face value of $1,000,000, and selling for $980,000 would be selling with a
dollar discount of D = F P = $1,000,000 $980,000 = $20,000. Given D = $20,000, F = $1,000,000 and t = 90,
the Treasury bill would be quoted at the following yield:
Yd =

$20 ,000 360

= 0.02(4) = 0.0800 or 8.00%.

$1,000 ,000 90

20. You have created a four bond portfolio with a duration of 6.0729. The particulars of these bonds are given in the
table below. What is the duration of the 7% 5 year bond?
(7)
Bond

Price

Yield

Par Value

Duration

9% 5yr

108.1109

8%

45000

3.254

7% 5yr

96.0436

9%

32000

9% 10yr

82.7951

12%

67000

5.875

7% 15yr

120.9303

5%

58000

9.745

Bond

Price

Yield

Par
Value

Mkt.
Value

Weight

Duration

DXW

10% 5yr

108.1

8%

45000

48645

0.2373207

3.254

0.772242

8% 5yr

96.04

9%

32000

30732.8

0.1499338

9% 10yr

82.8

12%

67000

55476

0.27064658

5.875

1.590049

7% 15yr

120.9

5%

58000

70122

0.34209892

9.745

3.333754

204975.8

5.696044

So, 6.0729 = 5.69604 + 0.149934D

Solving, we get D = 2.5135
21. Four bonds with 6, 12 18 and 24 months of maturity and $10000 face value are selling for $9400, $8900, $9484
and $9625 respectively. The first two are discount bonds, the third one pays 8% and the last one pays 9%/year
coupon (semi-annually). Using the bootstrapping method, calculate the 6, 12, 18 and 24 month zero rates.
(12)
Return from 6 month bond = (600/9400)x2 = 12.766% per annum with semi-annual compounding.
Return from 12 month bond = (1100/8900) = 12.36% per annum with annual compounding.
For the 18 month bond, we can write
9484 = 400/(1.12766)

0.5

+ 400/(1.1236) + 10400/(1+R)

or
9484 = 376.678 + 355.998 + 10400/(1+R)
Or
8751.324 = 10400/(1+R)
Or
(1+R)

1.5

1.5

1.5

1.5

= 1.1884

So
1 + R = 1.1219
thus,

R = 0.1219 = 12.19%.
9625 = 450/(1.12766)

0.5

+ 450/(1.1236) + 450/(1+.1219)

or
9625 = 423.763 + 400.4984 + 378.6878 + 10450/(1+R)
or
8422.051 = 10450/(1+R)
or

(1+R) = 1.24079
So
1 + R = 1.11391
thus,

R = 0.11391 = 11.391%.

1.5

+ 10450/(1+R)

22. An investor has a 5 year investment horizon and is considering the purchase of a bond that has 12 years to
maturity. This bond has a 6% coupon and is priced now at 8% YTM for $858.15. This investor hopes to reinvest his
coupon payments at 6% per year in the next 5 years and is expecting that at the time of the sale of the bond, the
bonds YTM will be 10%. What will be this investors total return in these 5 years in equivalent annual yield term?
PVIFA7,10% = 9.8986.
(10)
5

Coupon + Interest on interest = $60*[(1.06) 1]/0.06 = $338.225

Projected sale price at the end of year 5 = (60*9.8986) + 1000*0.5132)
= $1107.07
Total dollar return in year 5 = $1445.299
So, semi-annual total return = [1445.299/858.15]

1/5

1 = 10.988%

Thus, EAY is = 10.988%

23. (a) Given that the zero rates for STRIPS are: 5.6%, 5.8%, 5.92% and 6.04% for 1, 2, 3 and 4 year maturities,
find the 1year forward rate in year 3. Also find the 2 year forward rate in year 2.
(b) Given that the one year forward rates for years 1, 2, 3 and 4 are 6.75%, 6.65%, 6.80% and 6.70%, find the 2
and 3 year zero rates prevailing today.
(5+5)
4

a) (1.0604) = (1.0592) (1+F)

F = 1.26438/1.18832 1 = 6.4%
4

(1.0604) = (1.058) (1+F)

(1+F) = 1.26438/1.11936 Solving, we get F = 6.28%

--------------------------------------------------------------------------------------------------------2
b) (1+Z) = (1.0675)(1.0665) Solving, we get Z = 6.7%
3

(1+Z) = (1.0675)(1.0665)(1.068) Solving, we get Z = 6.73%

________________________________________________________________________________________________
D=
(price if yield declines) (price if yield rises)
2*(Initial price)*(change in yield in decimals)
C=

V+ + V- - 2V0
2*V0*(y)2
2

Convexity adjustment: Cx(y) x100