You observe the following information on 2-year and 10-year

Treasury bonds trading in the market (Semi-annual, Actual/Actual):

Bond 1: Treasury 0.70% 31 October 2019

Clean Price: 98.325

Yield (%): 1.5791

Bond 2: Treasury 2.25% 15 November 2027

Clean Price: 96.435

Yield (%): 2.6589

Both bonds have 181 days in the current coupon payment period.

Assume a financing rate of 0.345% (Actual/360) per annum.

Calculate the forward prices and yields of the two bonds for

settlement on 21 February 2018 (92 days).

(ii) You forecast a widening in the yield spread of 50bp on a 3-month

horizon. Is there a profitable opportunity based on your forecast?

Would there be a profitable opportunity if you instead forecast a

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IC314 2020/21 A 800

narrowing yield spread, and under which circumstances? Briefly

explain.

(iii)Next, using the information in the table, calculate the PV01 of both

bonds [Please use the approximation formula when computing the

modified duration, and show your full working calculations]. How

would you structure the trading position per USD 10mn of

exposure in the 10-year bond? What type of risk are you hedging

in this case?

(iv)You observe that forward short-term interest rates are above the

forward guidance provided by the Federal Reserve. Based on this

observation, and using the information provided in the opening

statement above, briefly discuss the risk to your chosen trading

strategy.

(v) Briefly discuss factors that might contribute to a higher term

premium on long-maturity bonds with respect to short-rate

instruments.