Problem 1: The 6-month, 12-month, 18-month, and 24-month zero rates are 4%, 4.5%, 4.75%, and 5%, with semi-annual compounding.
(a) What are the rates with continuous compounding?
(b) What is the forward rate for the 6-month period beginning in 18 months?
(c) What is the value of an FRA that promises to pay 6% (compounded semi-annually) on a principal of $1 million for the 6-month period starting in 18 months?
Problem 2: Portfolio A consists of a 1-year zero-coupon bond with a face value of $2,000 and a 10-year zero-coupon bond with a face value of $6,000. Portfolio B consists of a 5.95-year zero-coupon bond with a face value of $5,000. The current yield on all bonds is 10% per annum.
(a) Show that both portfolios have the same duration.
(b) Show that the percentage changes in the values of the two portfolios for a 0.1% per annum increase in yields are the same.
(c) What are the percentage changes in the values of the two portfolios for a 5% per annum increase in yields?
Problem 3: The future price for the June 2005 CBOT bond futures contract is 118-23.
(a) Calculate the conversion factor for a bond maturing on January 1, 2021, paying a coupon of 10%.
(b) Calculate the conversion factor for a bond maturing on October 1, 2026, paying a coupon of 7%.
(c) Suppose that the quoted prices of the bonds in (a) and (b) are 169.00 and 136.00, respectively. Which bond is cheaper to deliver?
(d) Assuming that the cheapest-to-deliver bond is actually delivered, what is the cash price received for the bond?
Problem 4:
Suppose that the term structure of interest rates is flat in the United States and Australia. The USD interest rate is 7% per annum and the AUD rate is 9% per annum. The current value of the AUD is 0.62 USD. Under the terms of a swap agreement, a financial institution pays 8% per annum in AUD and receives 4% per annum in USD. The principals in the two currencies are $12 million USD and 20 million AUD. Payments are exchanged every year, with one exchange having just taken place. The swap will last 2 more years. What is the value of the swap to the financial institution? Assume all interest rates are continuously compounded.