2.4 Use the example in 2.3 above to discuss which bond trading strategies would you implement to take advantage of this information. You are expected to provide a critical analysis specifically considering factors such as bond maturity, coupon and yield level. Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (5%) TOTAL (33%) 2.3 A 100 par value bond with 3 years to maturity and a 11 percent coupon has a yield to maturity of 10 percent. Interest is paid semi-annually. Assume no arbitrage. If the yield decreases by 200 basis points, what is the percentage price change for this bond using the duration rule? Explain why this estimate is likely to be an inaccurate measure of the actual change in the bond's value. What is the amount of the estimation error using only the duration rule for estimation? Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (6%) 2.4 Use the example in 2.3 above to discuss which bond trading strategies would you implement to take advantage of this information. You are expected to provide a critical analysis specifically considering factors such as bond maturity, coupon and yield level. Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (5%) TOTAL (33%) PVC*t Duration of a bond = PVC PVC = Present value of the cash flow Discounted at YIELD TO MATURITY or YTM Present value = Future value * PVF PVF = Present value factor = 1/(1+i)^t i = discount rate Actual price of the Bond = PVC Interest is paid semuannually. Hence semiannual coupon rate = 11%/2 = 5.50% Semiannual YTM = 10%/2 = 5% RS BER Hence current Bond price PVC = 102.54 Semiannual Duration of the Bond = 541.47 102.54 = 5.28 Annual Duration of the bond = 2.640 Years YTM or yield to maturity = 10% Semiannual YTM = 10% /2 = 5% Semiannual Modified Duartion = 5.28 / (1+5%) = 5.28/1.05 = 5.029 Annual Modified Duartion = 5.029/2 = 2.515 Modified Duartion will show the approximate change in the price of the Bond due to 1% chnage in the market yield. As we know that Market yield and bond price has inverse relationship. Here the Annual Modified Duartion is 2.515. It measn if Market yield increses/ Decreases by 1%, then the Vind price will Decrease/ Increase by 2.515% Hence if market vild has decreased by 200 basis 1% chnage in the market yield. As we know that Market yield and bond price has inverse relationship. Here the Annual Modified Duartion is 2.515. It measn if Market yield increses/ Decreases by 1%, then the Vind price will Decrease/ Increase by 2.515% Hence if market yield has decreased by 200 basis points or 2% then the on an approximation the bond price will increase by = 2% 2.515 = 5.029% Hence approximate change(Increase) in price = Current price*% change = 102.54* 5.029% = 5.16 hence as per duration Rule if Yield decreases by 200 basi point or 2% then the new bond price will be = 102.54+ 5.16 = 107.69 Estimatated change in price as per duration rule is not accurate, because it will only show the approximate change in price. It will not show the exact price change. Exact price change can be calculated by discounting the Future cash flows with the revised Yield. Revised annual yield = 10% -2% = 8% Semiannual yield = 8% /2 = 4% DAH Actual price will be 107.86 after 2% decrease in market yield. Bus as per duration rule, the estimated price = 107.69 Estimation error = 107.69- 107.86 = - 0.17 B PVF@4% C= A'B PVC Semiannual A Cash flow 1 5.50 Semi Annual Coupon 2 5.50 Semi Annual Coupon 3 5.50 Semi Annual Coupon 4 5.50 Semi Annual Coupon 5 5.50 Semi Annual Coupon 8 5.50 Semi Annual Coupon 6 100 Maturity value 0.981541=1/(1+49) 1 0.92456 =1/(1+496) 2 0.88900|=1/(1+4963 0.85480 =1/(1+49644 0.82193 =1/(1+4%) 5 0.79031 =1/(1+496)^6 0.79031 =1/(1+496)^6 Revised price 25.29 25.09 24.89 24.70 24.52 24.35 79.03 107.86 B PVF @5% C=A'B PVC Semiannual Cash flow 1 5.50 Semi Annual Coupon 2 5.50 Semi Annual Coupon 3 5.50 Sem. Annual Coupon 4 5.50 Semi Annual Coupon 5.50 Semi Annual Coupon 6 5.50 Semi Annual Coupon 6 100 Maturity value 0.95238 =1/(1+5%6^1 0.90703 -11+5%)^2 0.80384)=1/(1+5%) 3 0.82270 =1/(1+5% 4 0.78353 =1/(1+5%)^5 0.74622 -1/(1+5966 0.74622 -1/(1+5966 Tota! PVC't 5.24 4.00 4.75 452 54.31 24.10 74.82 102 54 25.24 29.08 E14.25 E18.10 21.55 E24.63 447.731 4541.47 5 2.4 Use the example in 2.3 above to discuss which bond trading strategies would you implement to take advantage of this information. You are expected to provide a critical analysis specifically considering factors such as bond maturity, coupon and yield level. Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (5%) TOTAL (33%) 2.3 A 100 par value bond with 3 years to maturity and a 11 percent coupon has a yield to maturity of 10 percent. Interest is paid semi-annually. Assume no arbitrage. If the yield decreases by 200 basis points, what is the percentage price change for this bond using the duration rule? Explain why this estimate is likely to be an inaccurate measure of the actual change in the bond's value. What is the amount of the estimation error using only the duration rule for estimation? Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (6%) 2.4 Use the example in 2.3 above to discuss which bond trading strategies would you implement to take advantage of this information. You are expected to provide a critical analysis specifically considering factors such as bond maturity, coupon and yield level. Support your answer with calculations and/or reasons behind. The maximum word count is 200 words (5%) TOTAL (33%) PVC*t Duration of a bond = PVC PVC = Present value of the cash flow Discounted at YIELD TO MATURITY or YTM Present value = Future value * PVF PVF = Present value factor = 1/(1+i)^t i = discount rate Actual price of the Bond = PVC Interest is paid semuannually. Hence semiannual coupon rate = 11%/2 = 5.50% Semiannual YTM = 10%/2 = 5% RS BER Hence current Bond price PVC = 102.54 Semiannual Duration of the Bond = 541.47 102.54 = 5.28 Annual Duration of the bond = 2.640 Years YTM or yield to maturity = 10% Semiannual YTM = 10% /2 = 5% Semiannual Modified Duartion = 5.28 / (1+5%) = 5.28/1.05 = 5.029 Annual Modified Duartion = 5.029/2 = 2.515 Modified Duartion will show the approximate change in the price of the Bond due to 1% chnage in the market yield. As we know that Market yield and bond price has inverse relationship. Here the Annual Modified Duartion is 2.515. It measn if Market yield increses/ Decreases by 1%, then the Vind price will Decrease/ Increase by 2.515% Hence if market vild has decreased by 200 basis 1% chnage in the market yield. As we know that Market yield and bond price has inverse relationship. Here the Annual Modified Duartion is 2.515. It measn if Market yield increses/ Decreases by 1%, then the Vind price will Decrease/ Increase by 2.515% Hence if market yield has decreased by 200 basis points or 2% then the on an approximation the bond price will increase by = 2% 2.515 = 5.029% Hence approximate change(Increase) in price = Current price*% change = 102.54* 5.029% = 5.16 hence as per duration Rule if Yield decreases by 200 basi point or 2% then the new bond price will be = 102.54+ 5.16 = 107.69 Estimatated change in price as per duration rule is not accurate, because it will only show the approximate change in price. It will not show the exact price change. Exact price change can be calculated by discounting the Future cash flows with the revised Yield. Revised annual yield = 10% -2% = 8% Semiannual yield = 8% /2 = 4% DAH Actual price will be 107.86 after 2% decrease in market yield. Bus as per duration rule, the estimated price = 107.69 Estimation error = 107.69- 107.86 = - 0.17 B PVF@4% C= A'B PVC Semiannual A Cash flow 1 5.50 Semi Annual Coupon 2 5.50 Semi Annual Coupon 3 5.50 Semi Annual Coupon 4 5.50 Semi Annual Coupon 5 5.50 Semi Annual Coupon 8 5.50 Semi Annual Coupon 6 100 Maturity value 0.981541=1/(1+49) 1 0.92456 =1/(1+496) 2 0.88900|=1/(1+4963 0.85480 =1/(1+49644 0.82193 =1/(1+4%) 5 0.79031 =1/(1+496)^6 0.79031 =1/(1+496)^6 Revised price 25.29 25.09 24.89 24.70 24.52 24.35 79.03 107.86 B PVF @5% C=A'B PVC Semiannual Cash flow 1 5.50 Semi Annual Coupon 2 5.50 Semi Annual Coupon 3 5.50 Sem. Annual Coupon 4 5.50 Semi Annual Coupon 5.50 Semi Annual Coupon 6 5.50 Semi Annual Coupon 6 100 Maturity value 0.95238 =1/(1+5%6^1 0.90703 -11+5%)^2 0.80384)=1/(1+5%) 3 0.82270 =1/(1+5% 4 0.78353 =1/(1+5%)^5 0.74622 -1/(1+5966 0.74622 -1/(1+5966 Tota! PVC't 5.24 4.00 4.75 452 54.31 24.10 74.82 102 54 25.24 29.08 E14.25 E18.10 21.55 E24.63 447.731 4541.47 5