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You are an investment manager for Lemon County. You are given the following in- formation about the yields of U.S. Treasury strips (which are zero-coupon,
- You are an investment manager for Lemon County. You are given the following in- formation about the yields of U.S. Treasury strips (which are zero-coupon, or pure discount, bonds which pay $100 at maturity): r1 = 3%, r2 = 4%, r29 = 6.1%, and r30 = 6.0%, where rj is the yield-to-maturity on a j-year strip. Assume that all cash flows are riskless and we can borrow and lend at the stated rates. You buy 50,000 30-year strips and partially finance these by issuing 5, 000 2-year strips (i.e., you are borrowing money by promising to pay $500, 000 = 5, 000 $100 in two years).
- (a) How much of Lemon Countys money are you investing (i.e., what is the net investment)?
- (b) Suppose that one second after you make the above investments, the Federal Re- serve Board announces that it is taking steps to raise interest rates. Assume that the yields on all of the strips immediately increase by one percentage point (i.e., r1 = 4%, r2 = 5%, r29 = 7.1%, and r30 = 7.0%). By how much (in dollars and in percentage terms) does the value of the countys investment change due to the unexpected announcement?
- (c) After the announcement, what are the forward rates of interest f2 and f30?
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