A dealer in government securities is considering buying $ 525 million in 10- year Treasury notes and $ 1,475 million dollars in six- month Treasury bills. Current yields on the T- notes average 5.15 percent, while six- month T- bill yields average 1.28 percent. The dealer can currently borrow $ 2,000 million through one- week repurchase agreements at an interest rate of 1.20 percent. Compute the dealer's expected carry income in each of the following scenarios. ( Hint: A spreadsheet can be most useful here.)
a. The dealer purchases the T- notes and T- bills and finances them with the RP under the terms stated.
b. Same as part ( a) except interest rates change to 5.30 percent on the T- notes, 3.40 percent on the T- bills, and 3.55 percent on the RP, and the dealer must refinance the T- note and T- bill purchases at the new RP rate.
c. Same as part ( b) except the dealer had not purchased the T- notes and T- bills until after interest rates changed.
d. Repeat part ( b) in the case where rates changed to 5 percent on the T- notes, 3.10 percent on the T- bills, and 2.5 percent on the RP.
e. Repeat part ( b) except the dealer had not purchased the T- notes and T- bills until after the interest rates changed.
f. Based on the results from parts ( a) to ( e), is it always good for the dealer when interest rates rise? How about when they fall? Please explain.
g. Could the dealer have benefited by a short position in part ( b) or ( d)? Please explain.