Question 3.20 Marks) (A) An investor bought an US Treasury Bond that pays annual 5% coupon with a maturity of 4 years. Three months (or 90 days) later, the investor is contemplating to sell the bond at an annual 5.75% yield to maturity. In the market, the US Treasury bond dealer is making a bid at around 95.01% and the investor seems to be willingly to sell it around this price. Should he sell his bonds at the market bid price? Note: The US Treasury Bond follows a Act/360 convention (6 Marks) (B) The "bid" and "ask yields for a 100-day US Treasury Bill were quoted by a bond dealer as 5.95% and 5.87%, respectively. The face value of this US Treasury Bill is $100,000. Shouldn't the "bid yield" be less than the "ask yield", becase the "bid yield" indicates how much the dealer is willing to pay and the "ask yield" is what the dealer is willing to sell the Treasury bill for? Please explain your view on this with an illustration of calculation. (4 Marks) C) DC forecasts that the current spot rate yield curve will steepen further in the near future. He wants to capitalize on this steepening view by taking a combination of long/short positions of 2-year bonds and 4-year bonds so that the modified duration is neutral. The steepening will take place as in the diagram illustrated below, where AY equals the change in yield. Yield HAY Time 4year 2year Since DC forecasts the yield curve to steepen how should DC implement the long and short combination strategy using 2-year and 4-year bond? (2 Marks) (1) In designing the trade in 6), how much principal (face value) in the 4-year bond would be required if the principal (or face value) in the 2-year bond is $10,000. (5 Marks) (iii) Calculate the net investment amount of the initial combined position. (3 Marks) Question 3.20 Marks) (A) An investor bought an US Treasury Bond that pays annual 5% coupon with a maturity of 4 years. Three months (or 90 days) later, the investor is contemplating to sell the bond at an annual 5.75% yield to maturity. In the market, the US Treasury bond dealer is making a bid at around 95.01% and the investor seems to be willingly to sell it around this price. Should he sell his bonds at the market bid price? Note: The US Treasury Bond follows a Act/360 convention (6 Marks) (B) The "bid" and "ask yields for a 100-day US Treasury Bill were quoted by a bond dealer as 5.95% and 5.87%, respectively. The face value of this US Treasury Bill is $100,000. Shouldn't the "bid yield" be less than the "ask yield", becase the "bid yield" indicates how much the dealer is willing to pay and the "ask yield" is what the dealer is willing to sell the Treasury bill for? Please explain your view on this with an illustration of calculation. (4 Marks) C) DC forecasts that the current spot rate yield curve will steepen further in the near future. He wants to capitalize on this steepening view by taking a combination of long/short positions of 2-year bonds and 4-year bonds so that the modified duration is neutral. The steepening will take place as in the diagram illustrated below, where AY equals the change in yield. Yield HAY Time 4year 2year Since DC forecasts the yield curve to steepen how should DC implement the long and short combination strategy using 2-year and 4-year bond? (2 Marks) (1) In designing the trade in 6), how much principal (face value) in the 4-year bond would be required if the principal (or face value) in the 2-year bond is $10,000. (5 Marks) (iii) Calculate the net investment amount of the initial combined position
