Q5) Answer the following questions that relate to bonds.

-A 2-year zero-coupon bond is selling for $890.00. What is the yield to maturity of this bond?

-The price of a 1-year zero coupon bond is $931.97. What is the yield to maturity of this bond?

-Calculate the forward rate for the second year.

-How can you construct a synthetic one-year forward loan of $ 1'000 (you are agreeing now to loan in one year)? State the strategy and show the corresponding cash flows. Assume that you can purchase and sell fractional portions of bonds. Show all calculations and discuss the meaning of the transactions.

Q6. (i) Discuss marking to market and margin accounts in the futures market.

      (ii) In an increasingly globalized investment environment, comparability problems become even greater. Discuss some of the problems for the investor who wishes to have an internationally diversified portfolio

(iii) Discuss rate anticipation swaps as a bond portfolio management strategy

(iv) Discuss contingent immunization. Is this form of bond portfolio management strategy an active, passive, or combination of both, strategy?

(v) (1.5 p) Although the expectations of increases in future interest rates can result in an upward sloping yield curve; an upward sloping yield curve does not in and of itself imply the expectations of higher future interest rates. Explain.

Q5.

9. (2 p) Answer the following questions that relate to bonds.

-A 2-year zero-coupon bond is selling for $890.00. What is the yield to maturity of this bond?

-The price of a 1-year zero coupon bond is $931.97. What is the yield to maturity of this bond?

-Calculate the forward rate for the second year.

-How can you construct a synthetic one-year forward loan of $ 1'000 (you are agreeing now to loan in one year)? State the strategy and show the corresponding cash flows. Assume that you can purchase and sell fractional portions of bonds. Show all calculations and discuss the meaning of the transactions.

Ans: Calculations are shown in the table below.

-Calculations for YTM of the 2-year zero: N=2, PV=-890.00, PMT=0, FV=1000, i₂=6.0.

-Calculations for YTM of the 1-year zero: N=1, PV=-931.97, PMT=0, FV=1000, i₁=7.3.

-Calculations for f₂ : (1.06)²/(1.073) - 1 = .047157502, f2 = 4.7157502%

-As shown by the calculations below, you purchase enough 2-year zeros to offset the cost of the 1-year zero. At time 1 the 1-year zero matures and you get $1,000. At time 2 the 2-year zeros mature and you have to pay 1.047157502 * $1,000 = $1,047.16. You are effectively borrowing $1,000 a year from now and paying $1,047.16 a year from then. The rate on this forward loan is $1,047.16/$1,000 - 1 = .04716, which equals the forward rate for the second year (f₂).

Strategy Cash FlowBuy a 1-year zero-coupon bond -$931.97Sell 1.047157502 2-year zeros $890.00 * 1.047157502 = $931.97Net Cash Flow $0.00

Q6. (1 p) Discuss marking to market and margin accounts in the futures market.

7 Ans: When opening an account, the trader establishes a margin account. The margin deposit may be cash or near cash, such as T-bills. Both sides of the contract must post margin. The initial margin is between 5 and 15% of the total value of the contract. The more volatile the asset, the higher the margin requirement. The clearinghouse recognizes profits and losses at the end of each trading day; this daily settlement is marking to market, thus proceeds accrue to the trader's account immediately; maturity date does not govern the realization of profits or losses.

22. (1.5 p) In an increasingly globalized investment environment, comparability problems become even greater. Discuss some of the problems for the investor who wishes to have an internationally diversified portfolio.

Ans: Firms in other countries are not required to prepare financial statement according to U. S. generally accepted accounting principles. Accounting practices in other countries vary from those of the U. S. In some countries, accounting standards may be very lax or virtually nonexistent. Some of the major differences are: reserve practices, many countries allow more discretion in setting aside reserves for future contingencies than is typical in the U. S.; depreciation practices, in the U. S., firms often use accelerated depreciation for tax purposes, and straight line depreciation for accounting purposes, while most other countries do not allow such dual accounts, and finally, the treatment of intangibles varies considerably across countries. Finally, the problem of obtaining financial information may be considerable for some international investments, varying currency exchange rates present additional complications, translation of statements into English is another complication; potential government expropriation of assets and political unrest may be problems in some countries. In general, for the individual investor, investing in global or international mutual funds is a less risky way to add diversification to the portfolio than is attempting to value individual international securities.

23. (1 p) Discuss rate anticipation swaps as a bond portfolio management strategy.

Ans: Rate anticipation swap is an active bond portfolio management strategy, based on predicting future interest rates. If a portfolio manager believes that interest rates will decline, the manager will swap into bonds of greater duration. Conversely, if the portfolio manager believes that interest rates will increase, the portfolio manager will swap into bonds of shorter duration. This strategy is an active one, resulting in high transactions costs, and the success of this strategy is predicated on the bond portfolio manager's ability to predict correctly interest rate changes consistently over time (a difficult task, indeed).