need the solution for B and C

2. Fixed Income (30 Marks) A. The relationship between bond prices and yields is very important to fixed-income investors. Explain the characteristics of a bond that affect its price volatility, and elaborate on the price/yield relationship for a callable bond. You should include a graph of this relationship in your answer. [10 marks] B. For small changes in yield, duration provides a good approximation of changes in the price of an option-free bond. However, for large changes in yield a convexity adjustment needs to be incorporated. With the aid of a diagram, discuss why a convexity adjustment is necessary and calculate the convexity adjustment for a bond with the following information: [8 marks] i. Initial price = 104.45. ii. Price if yields increase 1% = 100 iii. Price if yields decrease 1% = 109.16 C. Data for the Australian and U.S. spot rate curves is provided here: Maturity Australian Spot Rates U.S. Spot Rates 6-Months 2.31% 0.23% 1-Year 2.03% 0.37% 18-Months 1.98% 0.54% 2-Years 2.03% 0.70% 5-Years 2.48% 1.56% 10-Years 2.98% 2.17% Source: Bloomberg. 14th August 2015 i. Use pure expectations theory to explain the shape of the Australian yield curve. [4 marks] ii. If the spot rates presented in the table also incorporate a liquidity premium, what does this imply for the pure expectations yield curve for Australia? [2 marks] iii. Briefly explain, where would you expect the forward rate curve to be in respect to the spot rate curve for the U.S. [2 marks] iv. If you were to agree a rate today to borrow U.S. dollars for 1-year, but starting 1-year from now, what would be the agreed forward rate? [4 marks] 2. Fixed Income (30 Marks) A. The relationship between bond prices and yields is very important to fixed-income investors. Explain the characteristics of a bond that affect its price volatility, and elaborate on the price/yield relationship for a callable bond. You should include a graph of this relationship in your answer. [10 marks] B. For small changes in yield, duration provides a good approximation of changes in the price of an option-free bond. However, for large changes in yield a convexity adjustment needs to be incorporated. With the aid of a diagram, discuss why a convexity adjustment is necessary and calculate the convexity adjustment for a bond with the following information: [8 marks] i. Initial price = 104.45. ii. Price if yields increase 1% = 100 iii. Price if yields decrease 1% = 109.16 C. Data for the Australian and U.S. spot rate curves is provided here: Maturity Australian Spot Rates U.S. Spot Rates 6-Months 2.31% 0.23% 1-Year 2.03% 0.37% 18-Months 1.98% 0.54% 2-Years 2.03% 0.70% 5-Years 2.48% 1.56% 10-Years 2.98% 2.17% Source: Bloomberg. 14th August 2015 i. Use pure expectations theory to explain the shape of the Australian yield curve. [4 marks] ii. If the spot rates presented in the table also incorporate a liquidity premium, what does this imply for the pure expectations yield curve for Australia? [2 marks] iii. Briefly explain, where would you expect the forward rate curve to be in respect to the spot rate curve for the U.S. [2 marks] iv. If you were to agree a rate today to borrow U.S. dollars for 1-year, but starting 1-year from now, what would be the agreed forward rate? [4 marks]