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What is the estimated value of convexity

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Reference no: EM131004404

A. In a recent trading session, the benchmark 30-year Treasury bond's market price went up A1 dollars per $1000 face value to A2 dollars, while its yield fell from .07 to .068. The bond's market price then went up another A3 dollars per $1000 face value as the yield fell further to .0665 from .068. Report answers for the following (using average of latest two bond prices for duration and average of latest three bond prices for convexity):

1. Convexity, using the average of all three market prices of the bond in the denominator of the formula.

2. First modified duration, using average of first two market prices of the bond in the denominator of the formula.

3. Second modified duration, using average of second and third prices of the bond.

4. The expected rise in bond price if the interest rate were to fall another 20 basis points (.002) from .0665, using the average of two modified durations and convexity.

B. Estimate term structure of discount factors, spot rates and forward rates by using data on five semi-annual coupon paying bonds with $100 face value each: The bonds, respectively, have 1.25, 5.35, 10.4, 15.15 and 20.2 years to maturity; pay coupon at annual rates of B1, B2, B3, B4, and B5 percent of face value; and are trading at quoted spot market prices in dollars of B6, B7, B8, B9 and B10. Specify the discount factor function d(t) by a third degree polynomial with unknown parameters a, b, and c, as done in class. Using estimated d(t) function, determine spot rate and forward rate functions by assuming half-year compounding. Then write the values of the following based on your estimation.

5. Coefficient of parameter a in first bond price equation.

6. Coefficient of parameter b in first bond price equation.

7. Coefficient of parameter c in first bond price equation.

8. Coefficient of parameter a in second bond price equation.

9. Coefficient of parameter b in second bond price equation.

10.Coefficient of parameter c in second bond price equation.

11.Coefficient of parameter a in third bond price equation.

12.Coefficient of parameter b in third bond price equation.

13.Coefficient of parameter c in third bond price equation.

14.Coefficient of parameter a in fourth bond price equation.

15.Coefficient of parameter b in fourth bond price equation.

16.Coefficient of parameter c in fourth bond price equation.

17.Coefficient of parameter a in fifth bond price equation.

18.Coefficient of parameter b in fifth bond price equation.

19.Coefficient of parameter c in fifth bond price equation.

20.Parameter a.

21. Parameter b.

22. Parameter c.

23. Current price of a dollar at 5th year.

24.Current price of a dollar at 7th year.

25.Current price of a dollar at 10th year.

26.Current price of a dollar at 15th year.

27.Spot rate for term 2 year.

28.Spot rate for term 5 year.

29.Spot rate for term 10 year.

30.Spot rate for term 17 year.

31.Forward rate for half year period 2.5 to 3.0 years.

32.Forward rate for half year period 5.5 to 6.0 years.

33.Forward rate for half year period 10.5 to 11.0 years.

34.Forward rate for half year period 15.5 to 16.0 years.

C. Estimate the 2-year, 5-year, and 10-year key rate durations of a 20-year bond carrying a coupon of C1 percent on face value $100 paid semi-annually. The given term structure starts with C2 percent spot rate of interest at time zero and rises at a rate of 0.002 (.2%) per half year thereafter.

Take a 20 basis point (.002) move in each key interest rate to calculate the key rate durations by the method done in class and given in textbook. Report answers for the following:

35. Current fair price of the bond with the given term structure.

36. Price change needed to calculate 2-year key rate duration.

37. Price change needed to calculate 5-year key rate duration.

38. Price change needed to calculate 10-year key rate duration.

39. 2-year key rate duration.

40. 5-year key rate duration.

41. 10-year key rate duration.

D. Using the following data on the price of a bond and the corresponding interest rate (assuming a flat term structure) and regression method, estimate convexity and duration of the bond:

Price

Interest Rate

99

.06

100

.057

101.5

.052

102

.049

105

.044

106.5

.038

108

.033

108.5

.031

110.1

.028

42. What is the estimated value of Duration?

43. What is the estimated value of Convexity?

Attachment:- ExamData.xlsx

Reference no: EM131004404

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