Question Two

You are an Investment Analyst at MSC INC. On 06/01/2021 a new client has tasked you with investing $200m in the following two US corporate bonds holding $130m in AUTOSOL and the remaining $70m in BLOKU:

	AUTOSOL Bond	BLOKU Bond
Coupon	10%	12%
Par	$1,000	$1,000
T (years)	3	3
i	10%	14%
Moodys Rating	Aa1	Ba1

Your client instructs you that they wish to benefit from changes in the yield to maturity and insists that you actively manage the portfolio moving funds on a daily basis.

On the 07/01/2021 the Federal Reserve announces an imminent increase in the Federal Funds rate by 3%. Your analysis indicates that the respective yield to maturities on AUTOSOL and BLOOKU bonds will rise by 50% and 100% of the announced increase in the Federal Funds rate.

Required:

1. a) Compute the Price, Duration, Modified Duration and Convexity factor of AUTOSOL and BLOKU bonds using the information in the table above.

   [30 marks]

2. b) Calculate the Duration and Modified Duration of your bond portfolio. If you expect a large fall in interest rates, how would you change the amount invested in each bond and why?

   [20 marks]

3. c) Accounting for convexity, produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/01/2021. Explain the importance of accounting for convexity in this situation.

   [40 marks]

4. d) During financial crises bond prices fall and yield to maturities fall. Comment on whether this statement is true and how financial crises affect bond ratings.

   [1