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W. P.

Carey School of Business

Yield Curve:
We have used the data points given in Exhibit 1 (Coupon rate, price and maturity date) to find out
the yield to maturity for all the securities. Taking the current date as 15-Aug-2003 we have calculated
the remaining maturity for all the securities in half yearly terms. After that we have used the YEILD
function in Excel to calculate the appropriate annual-yield to maturity rate for each of the treasury
securities.
The syntax of the function is: YIELD( settlement, maturity, rate, pr, redemption, frequency)

Settlement - The settlement date of the security (i.e. the date that the coupon is purchased).
Maturity - The maturity date of the security (i.e. the date that the coupon expires).
Rate - The security's annual coupon rate.
Pr - The security's price per $100 face value.
Redemption - The security's redemption value per $100 face value.
Frequency - The number of coupon payments per year. This must be one of the following:
o 1
Annually
o 2
Semi-Annually (As treasury securities pay interest semi-annually)
o 4
Quarterly

For the security that matures in 6 months, we got yield as 0.882%, similarly for the security that matures
in 12 months, we got yield as 1.191% and so on.
Then we calculated the respective annualized spot rates / zero coupon yields by equating the discounted
cash flows to the price of security using different discount rates.
For example, for obtaining the zero coupon yield for 1-year treasury security we have used the
following approach:
($2.125/2)/(1+0.00882/2)1 + $102.125.0/(1+z2/2)2 = $100.9254, then we have z2 =1.193%.
Using this 0.5 year and 1 year zero coupon yield, we have obtained the zero coupon yield for 1.5year security using the same principles (i.e. sum of the cash flows discounted at the respective discount
rates should equal to the current price of the bond). The price of remaining securities is calculated in a
similar manner.

Using the zero coupon yields calculated we have plotted the yield curve using various maturities and
their respective zero coupon yields. The yield curve is as shown below:

Yield Curve (Zero Coupon Yield)


7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0

10

15

20

25

30

Years

The yield curve is mostly normal with a slight inversion at the end after 24 years and a minor flat/hump
in the 8-10 year range.
Finding Relative Value Trades:
After we have calculate zero coupon yield for all the securities, we compared the zero coupon yields
with the Deutsche bank yields. If Deutsche bank yields were higher than zero coupon yields, then the
bonds are cheap in Deutsche banks perspective and we should buy them as the expected yield i.e. the
return is more. If Deutsche bank yields are lower than zero coupon yields then the bonds are rich in
Deutsche banks perspective. So the security is expensive and we shouldnt buy that security. In ideal
case Deutsche bank should short such bonds based on their belief, but it is very risky to short bonds
based on liquidity and a host of other reasons. We should neither buy nor sell these rich bonds.
After comparing all the 13 securities, we have identified 3 securities to be cheap, 8 securities to be rich
and 2 securities to be fairly valued from Deutsche bank. But of the securities that have some mispricing,
some of the securities offer higher profit potential compared to the others. In the cheap basket of
securities 1-year and 25-year treasury offers the highest profit potential at 5.1 and 1.8 bps. Some of the
remaining cheap category securities have very low mispricing, that the effective cost of trading will
neutralize the mispricing.