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TREASURY MANAGEMENT

REVIEWING EXERCISES
I. ALM Gap analysis and Trading
Problem 1
Given the following information
ABC National Bank
($ Millions)
Assets

Liabilities and Equity

Rate Sensitive
NonRate Sensitive
Non Earning
Total Assets

$200 (12%)
400 (11%)
100
$700

Rate Sensitive
NonRate Sensitive
Equity100
Total Liabilities and Equity

$300
300

(6%)
(5%)

$700

a. What is the GAP? Net Interest Income? Net Interest Margin? How much will net
interest income change if interest rates fall by 200 basis points?
b. What changes in portfolio composition would you recommend to management if you
expected interest rates to increase. Be specific.
Problem 2
The balance sheet of Capital Bank appears as follows:
Assets

Liabilities and Maturities

Short Term Securities and


Adjustable Rate Loans
Duration: 6 months
Fixed Rate Loans
Duration: 8 years
Nonearning Assets

Short Term and Floating


Rate Funds
Duration 6 months
Fixed Rate Funds
Duration: 30 months
Equity 170

Total Assets

$220
700
80
$1000

Total Liabilities and Net Worth

$560
270
$1000

Required:
a. Calculate the duration of this balance sheet.
b. Assuming that the required rate of return is 8 percent, what would be the effect on the
banks net worth if interest rates increased by 1 percent.
c. Suppose that the expected change in net worth is unacceptable to management. What
outcome could management take to reduce this change?

Problem 3
The 10-year bund has a duration of 8.5 years; the 10-year gilt has a duration of 8.2 years.
- The /EU exchange rate is 1.2767 Sterling Pound to an EU
- The current spread between the Gilt and the Bund is 91 bps. If you expect the spread to
widen to 160 points in a month.
How should you trade to benefit from the expectation assuming that the exchange rate does not
change over the course of the trade.
II. BOND & YIELD CURVE
Problem 1
Bond A is a 15-year, 10.5% semi-annual bond priced with a yield to maturity of 8%. Bond B has
the same maturity, same yield to maturity, but is a 7% semi-annual bond. Given that both bonds
have par values of $1,000.
a. Determine which is traded at discount, at par or premium.
b. Calculate duration and modified duration of these two bonds.
Problem 2
A bond for the Chelle Corporation has the following characteristics: Maturity 12 Years; Coupon
10%; Yield to Maturity 9.50% Duration 5.7 Years ; Convexity 48; Noncallable
a) Calculate the approximate price change for this bond using only its duration assuming its yield
to maturity increased by 150 basis points. Discuss the impact of the calculation, including the
convexity effect.
b) Calculate the approximate price change for this bond (using only its duration) if its yield to
maturity declined by 300 basis points. Discuss (without calculations) what would happen to your
estimate of the price change if this was a callable bond.
Problem 3
A trader holds a long position of $2.5 mil of the 10-year bond which has coupon rate of 9.5%. The
duration of the bond is 8.92, its price is $125, yield is 9%. To protect against the rise in interest
rates, the trader decides to hedge the position using zero-coupon bond which has a BPV of 0.0667.
Suppose that the yield beta is 1.5, what nominal value of the zero-coupon bond must be sold in
order to hedge the position?
Problem 4
Consider the following zero-coupon market rates:
(1y)
6.000%

(2y)
6.300%

(3y)
6.500%

(4y)
6.655%

a. Calculate the price of an 8%, 5-year bond paying annually.


b. Calculate the price of an 7% 3-year bond paying semi-annually.

(5y)
6.788%

Problem 5
1-, 2- and 3-year spot rates on Treasuries are 4%, 8.167% and 12.377% respectively. Consider a 3year, 9% annual coupon corporate bond trading at 89.464. The YTM is 13.50% and the YTM of a
3-year Treasury is 12%. Compute the nominal spread and the zero-volatility spread of the
corporate bond.
Problem 6
Bank B provides the following loans to an AAA rated company:
Loan 1: 3 years, 5% paying annually credit amount 100.
Loan 2: 2 years, principle repayment of 50% after 1 year, credit amount 100, 4% annually
On the capital market, three coupon bonds with AAA ratings (that is, with negligible default risk)
and yearly interest payments are traded:
Coupon bond 1: maturity in 1 year, nominal interest rate 0.04 p.a., full price 101.9616,
Coupon bond 2: maturity in 2 years, nominal interest rate 0.05 p.a., full price 105.3765
Coupon bond 3: maturity in 3 years, nominal interest rate 0.02 p.a., full price 98.3164.
a) Calculate the arbitrage-free price of a 1-year, a 2-year and a 3-year zero bond.
b) Calculate the net present value of both loans.
III. REPO
Problem 1
Consider a 90-day repo transaction in the 6% Government bonds, take a margin of 2%. The repo
rate is 7%, start date is 1 April 2012.
Clean price of the bond is 97.85. Interest has been accrued for 15 days (Day-count basis: 30/360).
a. Calculate the amount of termination proceed
b. On 1 May 2012, there has been a fall in the bond market and the price decreased to 93.65 (clean
price). Calculate the variation margin.
Problem 2
On April 1st, 2012, a corporate wished to invest DEM 50 million against German government
bonds for 7 days. The collateral is the 6% bunds due in April 2015. The repo rate 6.5%. The bund
price is 101.2305, which together with 1.0542 accrued interest (69 days). Haircut is 2%.
a. Calculate the face value of bunds required at the current market price which will equate to
DEM 50 million.
b. Calculate amount of termination money
Problem 3
A six-month CD is issued on January 1st, 2012 and matures on June 30, 2012; has a face value of
10,000,000 VND and a coupon of 15%. (30/360 day count)
a. Calculate the value of the CD at maturity
b. Assuming that the CD is trading on the secondary market and the yield for short 120-day paper
is 13.5%, on March 1st, at which price should an investor buy the CD?

c. On June 1st, the yield on short 30-day paper is 12%. The investor decides to sell the CD. What is
his/her rate of return earned from holding the CD? Is the investors decision to enter and exit the
market (buy and sell the CD) considered good investment decisions? Please explain your answer.
IV. MM DERIVATIVES & INTEREST RATE SWAP
Problem 1
Suppose that the 3-month rate is 6% and the 9-month rate is 6.5%. How much is the value of 3v9
FRA on a notional principal of $3mil?
Problem 2
A 2v6 FRA is priced at 6.4% for the contract period from 17 May to 17 Sep. Another 6v12 FRA is
priced at 6.55% for the contract period from 17 Sep to 17 Mar. Compute the 2v12 FRA price
Problem 3
A bank has a maturity mismatch of $3,000,000 from having made a three-month Eurodollar loan
and having accepted a six-month Eurodollar deposit. It wants to use the FRA to cover the interest
rate risk caused by this mismatch. The available 3v6 FRA for hedging is as follows:
Agreed rate: 6.5% Number of days in FRA period: 92 days. Assume that three months from today
the settlement (reference) rate is 4.75 percent. Determine:
a. The bank has to buy or sell the FRA?
b. How much is the settlement amount and cashflow to each party.
Problem 4
Jan 1st, a UK company has an outstanding fixed rate bond, face value $200 million at 7%, paying
quarterly, mature in one year. The company expected that interest would decrease in a near future.
Consequently, the company enters in an interest rate swap, swapping 7% for Libor.
Rate setting date
Libor

Jan 1st
7%

Apr 1st
6.5%

July 1st Oct 1st


6.2%
6%

Prepare the cashflow table of the swap for the company until maturity.
Problem 5
ABC is currently paying 6% for a 5-year $100 million loan. As a new company, ABC is facing
liquidity problem. Structure a Gibson swap in which ABC can take a cash break for the first 3
years and paying more in the remaining 2 years, knowing a similar loan with three year maturity is
yielding 5.5%
V. CREDIT DERIVATIVES
Problem 1

Bank made a $200M loan at 12%. The bank wants to hedge the exposure by entering a TRS with a
counterparty. The bank promises to pay the interest on the loan plus the change in market value in
exchange for LIBOR+40bp. If after one year the market value of the loan decreased by 3% and
LIBOR is 11% what is the net obligation of the bank?
Problem 2
A credit spread option has a notional of $100M with a maturity of one year. The underlying
security is a 8% 10-year bond issued by corporation XYZ. The current spread is 150bp against 10year Treasuries. The option is European type with a strike of 160bp.
Assume that at expiration Treasury yield has moved from 6.5% to 6% and the credit spread
widened to 180bp.
Problem 3
A portfolio consists of one (long) $100M asset and a default protection contract on this asset. The
probability of default over the next year is 10% for the asset, 20% for the counterparty that wrote
the default protection. The joint probability of default is 3%. Estimate the expected loss on this
portfolio due to credit defaults over the next year assuming 40% recovery rate on the asset and 0%
recovery rate for the counterparty.
Problem 4
Portfolio consisting of a $10 million, 10%, 3-year par yield corporate bond and a long position in a
3-year CDS . The payout will be Notional*(100-B) where B is the price of the bond at expiration,
if the credit event occurs; Expected default probability in each of the next three years is 4%;
recovery rate is 30%. Assuming that CDS premium is paid the year end and default only happens
exactly at the middle of the year; T-note trades at 7%. Calculate the CDS premium using
a. The risk neutral probability approach
b. The actuarial approach
c. The bond credit spread approach

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