Question
Suppose the market price for a 4-year 7% non-Treasury bond with an embedded option and annual payments is $105.5536. Moreover, suppose the current Treasury yield
Suppose the market price for a 4-year 7% non-Treasury bond with an embedded option and annual payments is $105.5536. Moreover, suppose the current Treasury yield curve and Treasury spot curve are upward slopping as given in the following table, where all the rates are annually compounded:
1. Assuming the above yield curve, what is the absolute yield spread for this bond in basis points? Note, first you need to calculate the yield to maturity for this bond and then subtract the Treasury rate. 2. What is the static or zero-volatility spread (z-spread) for this issue in basis point relative to the Treasury spot rate curve given above? 3. Now, suppose this issue is putable in one year at $101 (meaning it is putable in year 1, 2 and 3 at $101) and is still traded at $105.5536. What is the OAS in basis points that you need to add to all interest rates on the binomial tree to make the resulting price equal to market price?Note, we assume equal probabilities for high and low states. Also, the tree can be downloaded from the link below, which is constructed based on the above yield to maturity rates and assuming the standard deviation of interest rate is 0.1. 4. Based on the z-spread and OAS you found in previous questions, estimate the spread (premium) for the option in basis points. Note, if the spread you find is positive you should enter a positive number and if it is negative you should enter a negative number here. 5. Consider the callable and putable bond in question#6 on Lab#8, which you solved on Post-class Quiz#8A. Regardless of your answer, suppose the bond value is $103.85. Suppose you have access to two similar bonds prices: a similar (only) callable bond with exact same call schedule, and a similar (only) putable bond with exact same put schedule. One of those bonds is trading at $104.15 and the other one is trading at $103.22, but we do not know the which one is trading at which price. Estimate the value of the put option. 6. In previous question, what is the value of similar vanilla bond that is neither callable or putable?
Maturity Yield to Maturity. Spot Rate \begin{tabular}{lll} 1 & 3.50% & 3.50% \\ 2 & 4.20% & 4.21% \\ 3 & 4.70% & 4.74% \\ 4 & 5.20% & 5.27% \end{tabular}Step by Step Solution
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