Posted: September 13th, 2017

Fixed Income

Paper, Order, or Assignment Requirements

QUESTION 1

Select two companies listed on the FTSE 100 Index (different from the ones that have been used in the lecture/seminar material of this module or as part of your assignments in any other modules. This will be checked.) For each company, select a coupon bond. The two bonds must have respectively 3 and 5 years remaining time to maturity. You can use for this purpose main financial newspapers (Financial Times, Wall Street Journal) or databases (Datastream, Bloomberg).

Assume that the term structure of interest rates can only shift upwards or downwards (i.e. at any point of time all interest rates at all maturities can only change by equal margins). Additionally, ignore any issue related to default risk.

• (a) Report clearly all bonds’ specifics and the source of your data. Then, calculate the Macaulay durations of the two bonds showing the full cash-flows working (Do not use the “duration” function on Excel; even if the quoted bond prices are given by your data-source, re-calculate them using the full cash-flow workings.) (15% mark)
• (b) Suppose that you have £1 million to invest and you wish to construct a bond portfolio which is immunized with respect to a 4-year horizon. You opt for a duration-immunization. How much par of each of the two bonds do you buy? (10% mark)
• (c) Suppose that during the first year of holding this portfolio, interest rates move: (i) up by 10 basis points; and (ii) up by 100 basis points. Show that your position is immunized by computing the change in value of your position at the 4-year horizon in each case (i) and (ii). How well is your portfolio protected against interest rate risk? Discuss and explain briefly your findings. (25% mark)

Your answer to Question 1 should be structured as follows:

•  All calculations for all questions must be presented in one Excel spreadsheet. In order to be awarded with the full mark for each question the spreadsheet must include all information and all correct calculations; it must also be well-presented, clear and user-friendly.
• Explain your answer for part B. Also provide an explanation on any assumptions made through out the assignment. The (brief) explanation and discussion requested for part C must also be presented in the Word file of the assignment (500 words for part C). Marking criteria will take into account clarity, correctness, rigor, efficiency, and parsimony. Overall word limit for Question 1on the Word file must be 750 words maximum.