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Homework Assignment #3
Due: October 24, Monday, drop in TAs box by 6PM
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4. Following table provides the information on the effective annual spot rates.
Maturity
0.5
1.5
2.5
3.5
4.5
5.5
Spot Rate
(%)
3.53 3.44 3.25 3.69 3.78 3.89 3.90 3.98 4.10 4.12 4.20 4.25
a. What are the six-month forward rates (effective annual number) for each period?
Use excel to draw the spot rate curve and the forward curve.
b. What is the price of a forward contract in which a 3-year 6% coupon bond will be
delivered in year 3? Assume coupon is paid semiannually with $3 per payment and
assume $100 par value.
c. Suppose one year later, all spot rates increase by 10 basis points, what is the market
value of the above forward contract then?
5. Suppose that bond ABC is the underlying asset for a futures contract with settlement six
months from now. You know the following about bond ABC and the futures contract: (1)
In the cash market ABC is selling for $80 (par value is $100); (2) ABC pays $8 in coupon
Assignment 3
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interest per year in two semiannual payments of $4, and the next semiannual payment
is due exactly six months from now; and (3) the current six-month interest rate at which
funds can be loaned or borrowed is 6% (annual number).
a. What is the theoretical futures price?
b. What action would you take if the futures price is $83?
c. What action would you take if the futures price is $76?
d. Suppose that the borrowing rate and lending rate are not equal. Instead, suppose
that the current six-month borrowing rate is 8% and the six-month lending rate is 6%.
What is the boundary for the theoretical futures price?
e. Suppose that bond ABC pays interest quarterly instead of semiannually. If you know
that you can reinvest any funds you receive three months from now at 1% for three
months, what would the theoretical futures price for six-month settlement be?
Assignment 3
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