P100 swaps maturing in year 1, 2, 3, and 4 are trading in the Botswana Interbank Market. Their annual swap-rates are as shown below.

Time to maturity	1	2	3	4	5
Coupon rate	1%	1.2%	1.25%	1.4%	1.8%
AAA (Bps)	15	20	25	30	50
ABB (Bps)	45	65	70	90	125

Question 2

1. Derive the underlying spot rates using bootstrapping methodology. After showing all the working summarize your rates to 4 decimal places in the form of a 3-column table.
2. Sketch the benchmark spot curve represented by the rates you derived in (a).
3. Explain one possible theory that can explain the shape of the curve.
4. Use the curve to predict the direction of any four major macro-economic variables, profits of banks and the value of fixed income portfolios. (

Question 3

1. Use the benchmark spot curve derived in the above question to predict the spot rates for Furnmat rated as ABB by Moodys.
2. Identify any five major (5) factors that are priced into AAA and ABBs spread by Moodys.

(2.5 marks)

3. Hence, price a 5 year 10% Furnmat Limiteds bond with an ABB rating and face value of P1 000 based on arbitrage free model leaving answer to two decimal places.
4. Identify the practical difficulties of pricing bonds using the arbitrage free model.

Estimate the YTM of Furnmats bonds using the trial-and-error method.

5. Hence, estimate the new price of Furnmarts bond if interest rates where to drop by 200 basis points using modified duration. Use four decimal places in all your calculations and leave your final answer to decimal places. (