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Capital Markets Homework Assignment for Class Session 3 Preparation for Thursday, November 7th,
2002 Topic: Bond Arbitrage and T-Bills Preparatory Readings:
F&I,
Chapter 5 (pp. 93-95) Livingston,
Chapter 8 (pp. 121-128) (CP) 1.
Use the attached page from the Nov. 16th 1999 Wall Street Journal (quotations as of Nov. 15th). There
is a Treasury bill that matures on Jan. 6th, 2000.
Assume settlement (payment) on Nov 16th. a)
What
is the price you would have to pay to buy this bill at the quoted price
on Nov. 16th? b)
What
is the bill’s quoted bank discount asked yield? c)
What
is the implicit compounding period assumed in calculating this yield?
d)
Adjust
this yield to compare it with the quoted yield on U.S. Treasury notes
and bonds (i.e. adjust it to a bond-equivalent yield). 2.
Use the attached issue of the WSJ
to answer the following questions.
Assume all trades settle (money exchanges hands) on November 15th
at the prices quoted. a)
If you wanted to buy a $1,000,000 face value position in the 7½
% Treasury Note which matures on November 15, 2001, what is the total price (or
“invoice” price) you would have to pay?
i.e. the WSJ quote plus
accrued interest? b)
What is the correct yield to maturity for this security at the
quoted price? c)
What would the quoted price of this bond have to be in order for
its yield to maturity to equal 6.00%? d)
Construct a schedule of cash flows resulting from the purchase of
$1,000,000 face value of this note assuming it is held to maturity. e)
Now assume that settlement is on November 16th, rather
than the 15th. What
is the total price the buyer would pay if the WSJ
quoted price remained the same? 3.
(Easier with a spreadsheet)
Refer to the bond in Question 2 to answer the following
questions. Settlement date remains Nov. 15, 1999. a)
Consider the schedule of cash flows constructed in Question 2
part (d) for the 7½% Treasury Note which matures on November 15, 2001. Can a portfolio of Treasury Strips be purchased which would
replicate the cash flows of the Treasury Note referred to in Question 2?
(Hint:
The answer is YES!) If
so, how? Use "ci"
T. Strips for coupon interest payments and "np" T. Strips for
the ending principal payment. (Hint:
use the T.Strips that are marked with the dots on the attached WSJ
Government Bond Page). b)
What would be the total cost of creating (purchasing) such a
strip portfolio? (You'll
need to construct a spreadsheet for this.) c)
Would the strip portfolio you constructed in b) be any more or
less “risky” than the Treasury Note?
Why is this important to know? d)
Now consider a situation where you already own the Treasury Note
in Question 2. What are the
total proceeds you could likely get for it if you sold it? e)
Compare the sales price calculated in d) to the cost of the
portfolio calculated in b). Is
there a difference? Is
there a profit (i.e., arbitrage)
opportunity for an investor here? f)
Now consider a situation where you already own the strip
portfolio that replicates the Treasury Note.
How much could you likely get for this portfolio if you
liquidated it (i.e. the bid price)? g)
Compare the sales price calculated in f) to the total price in
part a) of Question 2. Is
there a difference? Is
there a profit (i.e., arbitrage)
opportunity for an investor here?
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