PORTFOLIO ANALYSIS AND MANAGEMENT

BOND PROBLEM SET

1. The term structure of interest rates is currently flat r = 10%. You own a portfolio
of bonds as follows:

500 bonds, each with a 9.5% coupon maturing

in 7 years,
1200 bonds, each with a 6% coupon maturing in
4 years.
You wish to hedge against losses due to interest rate changes by taking a
position in 7 year discount bonds. What must the value of your position be?
After 4 years (when the 6% bonds have matured), how would you expect this
position to have changed assuming rates remain constant up to and including
that time period?

2. Portfolio X consists of a 1-year zero-coupon bond with a face value of $2,000,

and a 10year zero-coupon bond with a face value of $5000. Portfolio Y
consists of a 5.63 year zero-coupon with a face-value of $5000. The current
yield on all the bonds considered is 10% per annum.

a) What is the duration of the two portfolios?

b) Use duration to estimate the impact of a 0.5% decrease in the interest
rate on the present values of the two portfolios.

3. The term structure is flat at a rate of 6%. You are currently managing the
portfolio of bonds listed below:

long 500 of 6.5% coupon bonds t = 4 (maturity date)

long 1,000 of 8.0% coupon bonds t = 3
short 800 of 8.5% coupon bonds t=5

(i) If interest rates rise by 0.5%, what is the estimated effect of that
change on the value of your portfolio?
(ii) You wish to reconfigure the relative positions in the 6.5% and
8.0%bonds to make your portfolio insensitive to small rate changes.
How would you accomplish this goal?
4. A 5-year bond with a yield of 12% and face-value equal to $1000 pays an 8%
coupon at the end of each year.
a) What is the bond's price?
b) What is the bond's duration?
c) Use the duration to calculate the effect on the bond's price of a .2%
increase in its yield.
d) Recalculate the bond's price on the basis of a 12.2% yearly yield.

5. You are expecting a cash-outflow for a payment due in 1 year and 325 days
from now, and you are looking for an investment allowing you to get
"immunized" against fluctuations in the yields. The yield curve is flat at the
level of 13%. You are given the choice between the following two bonds:

i) A bond with a coupon rate of 14%, yearly interest payments,

and principal due in 2 years.
ii) A bond with a coupon rate of 12%, yearly interest payments,
and principal due in 2 years.

What is the duration of each bond, at the given level of the yields, and
which one of them should you invest in, given your objective? (In order to
fix ideas, when you calculate the duration of the bonds, you can assume that
the face-value of each one of them is equal to $1000).

6. You currently hold a portfolio consisting of 100 of 1-year T-bill selling for $960
and 150 3-year 5% coupon bonds. (Coupons are paid annually.) You want to
immunize your portfolio against small changes in interest rates by using futures
contract, written on 3-monts T-bill. How many futures contracts do you need to
achieve this goal? Is it a long a short position? The term structure is currently flat.

7. You observe the following anticipated floating rate swap payments, each based on
a notional $ 100 M. Assume semi-annual compounding.

Floating Payments

t=0 0.5 1 1.5

1 year swap 1M 1.1M
1.5 year swap 1M 1.1M 1.12M
a. Construct the implied term structure of LIBOR rates. What are the corresponding
swap rates?
b. You plan to sign a 1.5 year Eurodollar loan today (t = 0) for $l,000,000 for 1%
over LIBOR. What is the no arbitrage forecast of the interest payments you will
make at the end of each 6 month period?
c. Rates may go up and your floating rate payments increase. Conceptually, how
would you hedge this possibility?