Bond Pricing the RCY and bond management – Forward Rates and the Term Structure

Bond Pricing the RCY and bond management


(a) What are ‘bond characteristics’? Explain how these influence the way that a bond price changes in response to changes in market interest rates?

(b) Using the following UK government gilts currently in issue:
Treasury 8% 31st December 2015
Treasury 8% 31st December 2021
Treasury 6% 31st December 2028
Estimate the fair price of these £100 semi-annual bonds for a yield of 3% p.a. as at 31st December 2011 (it can be assumed that the yield curve is flat).
(c) If yields increase to 3.5% p.a. estimate the new fair price of the bonds in (b) above.

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(d) A 4 year bond of £100 face value has a coupon of £9 that is paid once per year. If the expected interest rates are 8% 7% 6% and 5% respectively for the next 4 years. Estimate the bond price.

(e) You buy an annual £100 bond with a 7% coupon bond when interest rates are 4% p.a. At this point in time the bond has 10 years until maturity. Interest rates rise to 5% p.a. immediately after your purchase and remain constant until you sell it in 6 years time. What is your Realised Compound Yield on this bond?

(f) What is the difference between active and passive approaches to bond portfolio management? Is either approach better than the other?

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Forward Rates and the Term Structure

Consider the following graph and table relating to the term structure of interest rates in June 2011.

Forward Rates and the Term Structure

Forward Rates and the Term Structure

 

Forward Rates and the Term Structure

Forward Rates and the Term Structure

(a) Calculate the following forward rates from the June term structure:
i) 1-year rate 3 years from now;
ii) 2-year rate 3 years from now;
iii) 5-year rate 5 years from now;
iv) 5-year rate 10 years from now.
(b) Discuss which of the theories of the yield curve best explains the shape of the term structure as at June 2011.

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Bond Pricing the RCY and bond management – Forward Rates and the Term Structure