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Consider the following information about an issue of UK gilt bonds with 3 year maturity. An individual gilt is currently selling at 79.58, has a
Consider the following information about an issue of UK gilt bonds with 3 year maturity. An individual gilt is currently selling at 79.58, has a yield-to-maturity of 4.5%, and a coupon rate of 3%. Recall the formulas for a coupon bond and for a loan with repayments: = + FV Coupon Bond: P = + + + (1+i) (1 + i)2 (1+i)" (1 + i)" CF CF CF Loan: L= + + + (1+i) (1 + i)2 (1+i)n a) Assuming the bond is correctly priced, calculate what its face value should be at this price. How much would it cost the bank to purchase 40,000 units of this issue of the bond? (10 points] b) Calculate the yearly payment if the bank decided to fund this pur- chase with a loan maturing in two years at an interest rate of 2% and discuss whether the bank is exposed to refinancing or reinvestment risk. (10 points) c) Which of these assets is more sensitive to changes in the interest rate? Should the bank be worried about an increase or a decrease in the interest rate? [5 points] Consider the following information about an issue of UK gilt bonds with 3 year maturity. An individual gilt is currently selling at 79.58, has a yield-to-maturity of 4.5%, and a coupon rate of 3%. Recall the formulas for a coupon bond and for a loan with repayments: = + FV Coupon Bond: P = + + + (1+i) (1 + i)2 (1+i)" (1 + i)" CF CF CF Loan: L= + + + (1+i) (1 + i)2 (1+i)n a) Assuming the bond is correctly priced, calculate what its face value should be at this price. How much would it cost the bank to purchase 40,000 units of this issue of the bond? (10 points] b) Calculate the yearly payment if the bank decided to fund this pur- chase with a loan maturing in two years at an interest rate of 2% and discuss whether the bank is exposed to refinancing or reinvestment risk. (10 points) c) Which of these assets is more sensitive to changes in the interest rate? Should the bank be worried about an increase or a decrease in the interest rate? [5 points]
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