64 GRAD STUDENTS ONLY Questions #33-36 are based on the following information: Research has shown that the movements of the US Treasury yield curve over time can be described by changes in three main factors: its level, its slope, and its curvature. The diagrams below illustrate the effects of cach of these three factors operating in isolation: Effects of level, slope, and curvature on yield curve A. Level B. Slope C. Curvature Interest rates (6) Interest rates (9) Interest rates) 7.0 7.0 6.8 6.8- 6,6 66 6.4 Level 6.2 6.0 5.8 Slope 5.6 5.4 5.4 5.4 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 Maturity in years Maturity in years Maturity in years In the next four problems we look at a bond strategy to profit from curvature changes: the butterfly trade. This trade involves three bonds of different maturities, here we use 2- and 10-year T-notes for the wings of the butterfly and the 5-year T-note for the "body." If we expect an increase in curvature, the 5-year YTM should move up relative to the 2- and 10-year YTMs. Given the information in the table below, construct an arbitrage or trading portfolio by 1) selling 1,000 of the 5-year notes and 2) buying quantities of the 2- and 10-year notes, such that 3) the net cost of the trading portfolio is zero, and 4) the DVOI of the trading portfolio is zero. All face amounts = $1.000, and remember that one basis point = 0.0001 = 1/100 of a percentage point, 6.8 66 6.4 6.2 6.0 5.8 Curvature 6.2 6.0 5.8 56 Maturity YTM Bond Price #of Bonds (% of face) Quantity Bought(+)/Sold(-) DVO1 2 years 4.50% 101 0 $0.19 5 years 5.50% -1,000 $0.42 10 years 6.00% 93 +Q10 $0.70 DV01 = Sche per basis point in value of one bond with face = $1,000 & price shown 13 pts 33. 13 pts 34. 12 pts 35. Que = Trading portfolio profit/loss if all YTMs by 15 basis points? $ Trading portfolio profit/loss if YTMs by 10 basis points and both YTM, and YTM, I by 10 basis points? (include a "+" or "-") $ 12 pts 36