Sac 300: Financial Mathematics: Question 1 (30 Marks)
Sac 300: Financial Mathematics: Question 1 (30 Marks)
Sac 300: Financial Mathematics: Question 1 (30 Marks)
(a) Suppose that the term structure of interest rates has the following schedule of spot
rates for maturities of 1,2,3 and 4 years
Use the term structure to find the price per 100 face amount to maturity for 5%
annual coupon structure maturing in 4 years
(6 marks)
(b) According to the current term structure of interest rates, the effective annual
interest rates for 1, 2 and 3 year maturity zero coupon bonds are
Year 1 2 3
Interest 0-8 0.10 0.11
Find the effective one-year forwrd effective annual rate of interest and two-year
forwrd effective annual rate of interest
( 6 marks)
(c) A loan is being repaid by 2n level payments starting one year after the loan is issued.
Just after the nth payment the borrower finds that he still owes ¾ of the original
amount. What proportion of the next payment is interest?
(6
marks)
(d) An amortized loan of 1000 is to be repaid with 24 monthly payments starting one
month after the loan is issued.The nominal interst rate convertible monthly is 0.09
for the first 18 months and 0.12 for the the final 6 months . Construct the
amortization table for this loan and find the amountv of princical repaid in the first
year
(6
marks)
(e) Cosider the following two portfolios of bonds
Portfolio 1: A 10 yr zero coupon bond with face amount of 100
Portfolio 2: A 5 yr zero coupon bond with face amount 41.39 combined with a 29
year zero coupon with face a mount 86.46.
Assume that the yield to maturity for all bonds is i = 10%,. Show that the present
value and the duration of the portfolios are matched at any time before 5 years if
the yield to maturity stays at 10%. Suppose that after one year the yield to maturity
for all bonds is 11%. Find the presnt values and Macaulay durations of the two
portfolios.
(6 marks)
Question 2 (20 marksa)
(a) Suppose that the yield rate and coupon rate on an n-coupon bond are the same.
Show that the duration is ä valued at the yield rate. Find the duration of a 6-
coupon bond with coupon rate of 10% per goupon period and yield rate of 10%
(6 marks)
(b) Liabilties of 1 each are due at the ends of periods 1 and 2. There are three
securities available to produce asset income to cover these liabilities as follows
(i) A bond due at the end of period 1 with coupon at rate 0.01 per period
valued at a periodic yield of 14%.
(ii) A bond due at the end of period 2 with coupon rate of 0.02 per period
valued at a periodic yield of 15%
(iii) A bond due at the end of period 2 with coupon rate of 0.20 per period,
valued at a periodic yield of 14.95%
Determine the cost of the portfolio that exacttly matches asset income to
liabilies due using
(3) Show that the combination of securities in (b) minimizes the cost of exact-
matching portfolios made up of a combination of the three securities
(a) You are given the following information for 4 bonds. All coupon and yield to
maturity rates are nominal annual convertible twice per year.
2 1 yr 6% 0.10
3 1½ yr 4% 0.15
4 2yr 8% 0.15
Find the associated term structure for zero-coupon bonds with maturities of ½
yr, 1 yr, 1 ½ yr and 2 yr.
(8 marks)
(b) According to the current term structure of interest rates the effective annual
interst rates , the effective annual interest rates for 1, 2, and 3 yr maturity
zetre-coupon bonds are
(a) Liabiliti payments of 100 each are due to be made in 2 , 4 and 6 years from now
. Asset cash fow consists of A1 in year 1 and A5 in year 5. The YTM for all
payments is effective annual interest at 105. An attempt is made to have the
asset cash flow immunize the liability cashflow by matching present value and
duration
(i) Find A1 and A5
(ii) Determine whether or not the conitions for Redington immunization are
satiafied at the effective annual rate of 10%.
(10 marks)
(b) The current term structure has the following nominal spot rates i
(a) An amortized loan of 10.000 has interest at 8% per year on the first 5000 of the
outstanding balance and 10% per year on the outstanding in excess of 5000. Suppose
that annual payments are 1500 for as long as necessary. Construct the amortazation
table for the loan
(10 marks)
(b) A loan of 10,000 at effective annual rate i = 0.08 is to repaid with 20 level annual
payments of amount k each. At the time of the 5th payment, the borrowe makes
an additional payment of amount