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Financial Economics Assignment 4 (2018-2019)

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Financial Economics

Assignment # 4

Year 2018-2019 

We have the following information about Treasury bonds being traded:

T  c  N  P 
1  0.00%  1,000  985.22 
2  4.00%  1,000  1,043.94 
3  5.50%  1,000  1,101.46 
4  7.75%  1,000  1,211.92 
5  8.25%  1,000  1,280.49 
6  7.50%  1,000  1,287.85 

1. Calculate the yield curve. Give details of your calculations for the bonds with maturities of
T = 1 and T = 2. Calculate the result of the others using the Excel “IRR” function.

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Financial Economics Assignment 4 (2018-2019)

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2. You are thinking of investing in the 5-year bond. The following table shows the yearly return
you would obtain depending on how long you hold the bond and the reinvestment and discount
rate. Complete the table and detail how you calculated your answers.

Reinv. and Disc.  Holding  Holding  Holding  Holding  Holding 


Rate  period: 1  period: 2  period: 3  period: 4  period: 5 
1.00%  6.63%    2.84%  2.38%  2.10% 
2.26%  2.26%  2.26%  2.26%  2.26%  2.26% 
5.00%  ‐6.46%  ‐0.90%  1.03%    2.60% 

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Financial Economics Assignment 4 (2018-2019)

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Financial Economics Assignment 4 (2018-2019)

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3. You find the high coupon on the 5-year bond particularly attractive and decide to buy it.
However, you know that you will need the money in exactly 3 years’ time, and that the rate at
which you could reinvest the coupons will not necessarily be the same as the rate at which the
bond’s subsequent payments will be discounted. The following table contains the yearly return
you will have obtained at the end of 3 years depending on the reinvestment rate and the discount
rate. Complete this table and show your calculations.

R. rate\ D. rate  1.00%  2.26%  5.00% 


1.00%  2.84%  2.18%  0.77% 
2.26%  2.92%  2.26%   
5.00%    2.43%  1.03% 

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Financial Economics Assignment 4 (2018-2019)

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Financial Economics Assignment 4 (2018-2019)

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4. Calculate the TSIR or zero-coupon yield curve.

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Financial Economics Assignment 4 (2018-2019)

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Financial Economics Assignment 4 (2018-2019)

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5. Imagine you are a bank manager and several of your customers would like to invest in
products with guaranteed returns. Always keen to give the best service, you decide to buy some
6-year Treasury bonds and sell them as strips, i.e. segregated into zero-coupon bonds.

a) Let’s imagine you don’t charge your customers any commission for this service and
that one of them decides to buy a bundle of 5,000 3-year strips. (In other words, you
sell your customer 5,000 3-year zero-coupon bonds with a face value equal to the
coupon paid by 6-year Treasury bonds.) What yearly return would your customer
expect to receive on this investment? How much would this customer have to pay the
bank for this bundle of strips?

b) What would your answer to the previous question be if your bank charged €400
commission on this operation?