Determine which spread the company would have to accept

Reference no: EM132271147

Problem One - Assume a company was able to issue a 5-year floating rate note at 12-month LIBOR. Neglect day count conventions.

(i) Prove by replication and no arbitrage that at every reset date this floating rate note trades at a clean price of 100 if the "market" has no information that the default risk of the company has changed since the issue date.

(ii) Assume an increase of interest rates caused a drop of the floating rate note's price in the middle of a coupon period to 99.0. In the bond market a concept called "return to rollover" is used. What do you think how this "return to rollover" is defined.

(iii) Assume that the credit risk of the issuer increased and at the first reset date the clean price of the floating rate note is 90.0. Determine approximately which spread the company would have to accept if it wants to issue a new floating rate note with a maturity of four years at par?

Problem Two - Assume you hold a 2-year coupon bond. You want to replace this bond by a portfolio of bonds with the same market value and $-Duration. How can you achieve this?

Reference no: EM132271147

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