Question 1 (10 Marks)

The following table is relevant to answer parts (a) to (c) of this question.

Assume you manage the following portfolio of liabilities.

Instrument	Coupon	Maturity	Face	Market	Market	Macaulay
		date	Value ($m)	Value ($)	Interest rate	Duration
DB03	6.77%	15-03-03	100	100,129,016.87	6.56/6.70	?
DB11	5.65%	15-03-11	100	100,607,102.57	5.53/5.57	7.77

Note: Today is the 15th March 2001 and there are 92 days between today and 15th June 2001. The DB03 market value is based on 6.70% yield and DB11 market value is based on 5.57% yield.

1. Assume that the $100m of DB03 in the table above was issued today to an institutional investor called BondBuy Ltd. If BondBuy holds the DB03 for 6 months and then sells it when the yield is 7%, what annualized return do they receive over the holding period? (2 Marks)

2. Calculate the Macaulay Duration for the DB03 bond. (5 Marks)

3. Today (15th March 2001) you receive a highly regarded economic forecast of interest rates in three months. The rate forecast for DB03 is 6.82/6.86 and the rate forecast for DB11 is 5.38/5.42.

1. Calculate the cost of funds for DB03 over the period 16th March 2001 to 15th June 2001 (assume DB03 yield in June is equal to the above forecast) (2 Marks)

2. Assume that you are required to raise $150mil today for a client. Which bond (DB03 or DB11) should you issue to raise the required funds? (Note: you can ignore any management ranges that would normally apply in the trading game) (1 Mark)