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Chap 03 - Financial Markets and Institutions

# Chap 03 - Financial Markets and Institutions

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# U9824613 阮德龍

Chapter 03
Interest rate and Security valuation
Question 22:
a.
t CFt PV of CFt Wt t × Wt
1 100 89.286 0.092 0.092
2 1100 876.913 0.908 1.816
total P0= 966.199 1 D = 1.908
The Duration is 1.908 years
b. Because the bond is zero-couon bond! the duration "ill e#ual to the nu\$ber o% eriods
until a bond \$atures.
&o! D = T = ' years.
c. The increasin( in the yield to \$aturity decreases the duration o% the bond. )ith the zero-
couon bond the yield to \$aturity increases \$a*e the duration o% zero-couon bond
increase in the sa\$e nu\$ber o% eriods.
Question 23:
a.
+or Ban* 1! an increase o% 100 basis oints in interest rate "ill cause the \$ar*et ,alues o%
assets and liabilities to decrease as %ollo"s-
• .oan-
/120!0000123+4n=10!i=135 6 /1!000!0000123+n=10!i=135 =/97'!737.'7.
• 8D-
/100!0000123+4n=10!i=115 6 /1!000!0000123+n=10!i=115 = /971!107.68.
Financial Markets and Institutions
U9824613 阮德龍
There%ore! the decrease in ,alue o% the asset "as /7!629.89 less than the liability.
+or Ban* 2-
• Bond-
/1!976!362.880123+n=7!i=135 = /870!077.08.
• 8D-
/82!7'00123+4n=10!i=115 6 /1!000!0000123+n=10!i=115 = /839!'18.73.
The bond ,alue decreased /'3!932.12! and the 8D ,alue %ell /'7!787.79. There%ore! the
decrease in ,alue o% the asset "as /'''.67 less than the liability.
b.
The assets and liabilities o% Ban* 4 chan(e in ,alue by di%%erent a\$ounts because the
durations o% the assets and liabilities are not the sa\$e! e,en thou(h the %ace ,alues and \$aturities
are the sa\$e. +or Ban* B! the \$aturities o% the assets and liabilities are di%%erent! but the current
\$ar*et ,alues and durations are the sa\$e. Thus! the chan(e in interest rates causes the sa\$e
9aro:i\$ate; chan(e in ,alue %or both liabilities and assets.
Question 24:
Financial Markets and Institutions
U9824613 阮德龍
a. T= ' years couon rate = 105 ar ,alue = /1!000
4ssu\$e < =105 se\$iannual
t CFt PV of CFt (PV of C! × t
0.' /'0 /77.62 /23.81
1 '0 7'.3' 7'.3'
1.' '0 73.19 67.79
2 '0 71.17 82.27
2.' '0 39.18 97.97
3 '0 37.31 111.93
3.' '0 3'.'3 127.37
7 '0 33.87 13'.37
7.' '0 32.23 17 '.07
' /10'0 /677.61 /3!223.07
total /1!000.00 /7!0'3.91

Duration is- D = /7!0'3.91=/1!000 = 7.0'391 years
b. < = 175 T= ' years se\$iannual couon rate = 105
1ar ,alue = /1!000
t CFt PV of CFt (PV of C! × t
0.' /'0 /76.73 /23.81
1 '0 7'.67 7'.3'
1.' '0 70.81 67.79
2 '0 38.17 82.27
2.' '0 3'.6' 97.97
3 '0 33.32 111.93
3.' '0 31.17 127.37
Financial Markets and Institutions
U9824613 阮德龍
7 '0 29.10 13'.37
7.' '0 27.20 17 '.07
' /10'0 /'33.77 /2!668.83
total /8'9.'3 /3!710.22
Duration is- D = /3!710.22=/8'9.'3 = 3.967'7 years
<= 165 T= ' couon rate = 105 ar ,alue = /1!000 se\$iannual
t CFt PV of CFt (PV of C! × t
0.' /'0 /76.29 /23.1'
1 '0 72.87 72.87
1.' '0 39.69 '9.'7
2 '0 36.7' 73.'
2.' '0 37.03 8'.08
3 '0 31.'1 97.'3
3.' '0 29.17 102.09
7 '0 27.02 108.08
7.' '0 2'.01 112.''
' /10'0 /786.3' /2!731.7'
total /798.69 /3!133.17

Duration is- D = /3!133.17=/798.69 = 3.9228 years.
c. 4s %ollo"-
>ield to \$aturity Duration
105 7.0'391 years
Financial Markets and Institutions
U9824613 阮德龍
175 3.967'7 years
165 3.9228' years
4s the yield to \$aturity increase! the duration "ill decrease.
Question 2":
a.
T = 7 years <= 105 couon rate = 105 ar ,alue = /1!000
se\$iannual
t
CFt
PV of CFt PV of CFt × t
0.' /'0 /77.62 /23.81
1 '0 7'.3' 7'.3'
1.' '0 73.19 67.79
2 '0 71.17 82.27
2.' '0 39.18 97.97
3 '0 37.31 111.93
3.' '0 3'.'3 127.37
7 /10'0 /710.'3 /2!872.73
total /1!000.00 /3!393.19
Duration is- D = /3!393.19= /1!000 = 3.3932 years
b.
8ouon rate = 105 ar ,alue = /1!000 < = 105 se\$iannual
Financial Markets and Institutions
U9824613 阮德龍
t
CFt
PV of CFt PV of CFt × t
0.' /'0 /77.62 /23.81
1 '0 7'.3' 7'.3'
1.' '0 73.19 67.79
2 '0 71.17 82.27
2.' '0 39.18 97.97
3 /10'0 /783.'3 /2!3'0.'9
total /1!000.00 /2!667.77
Duration is- D = /2!667.77=/1!000 = 2.66777 years.
c.
8ouon rate = 105 ar ,alue = /1!000 < = 105 se\$iannual
Duration is- D =
/1!861.62= /1!000 =
1.86162 years.
a.
4s the ti\$e to \$aturity decrease! the duration "ill decrease! too.
?aturity Duration
7 years 3.39319 years
3 years 2.66777 years
2 years 1.86162 years
Question 2#:
Financial Markets and Institutions
t
CFt
PV of CFt PV of CFt × t
0.' /'0 /77.62 /23.81
1 '0 7'.3' 7'.3'
1.' '0 73.19 67.79
2 /10'0 /863.87 /1!727.68
\$otal /1!000.00 /1!861.62
U9824613 阮德龍
Because the bond is zero-couon bond! the duration "ill be e#ual to the nu\$ber o% years to
\$aturity.
Then! the duration o% zero couon bond that has 8 years to \$aturity is D = 8 years
The duration o% zero couon bond i% the \$aturity increase to 10 years is D = 10 years.
The duration o% zero couon bond i% the \$aturity increases to 12 years is D = 12 years.
Question 2%-
a. 8ouon rate = 13.765 < = 105 T = ' years annual aid
1ar ,alue = /1!000
t CFt PV of CFt PV of CFt × t
1 /137.6 /12'.09 /12'.09
2 137.6 113.72 227.77
3 137.6 103.38 310.17
7 137.6 93.98 37'.92
' /1!137.6 /706.36 /3.'31.8
\$otal /1!172.'3 /7!'70.39
Duration is- /7!'70.39= /1!172.'3 = 7.0002 years or 7 years 9aro:i\$ately;
b. &ho" that! i% interest rates rise to 10 ercent "ithin the ne:t year and that i% your
in,est\$ent horizon is %our years %ro\$ today! you "ill still earn a 9 ercent yield on your
in,est\$ent.
2alue o% bond at end o% year %our- 12 = 9/137.66 /1!000;  1.11 = /1!027.86
+uture ,alue o% interest ay\$ents at end o% year %our-
/137.6@+23+ 97! 115; = /678.06
+uture ,alue o% all cash %lo"s at n = 7-
8ouon interest ay\$ents o,er %our years /''0.7
3nterest on interest at 11 ercent 97.66
2alue o% bond at end o% year %our /1!027.86
Total %uture ,alue o% in,est\$ent /1!672.92
>ield on urchase o% asset at /1!027.86 = /1!672.92@123+97! i; ⇒i = 10.00235.
Financial Markets and Institutions
U9824613 阮德龍
Question 2&:
a. ar ,alue = /10!000 couon rate = 85 < =105 T = ' years annual aid
t CFt PV of CFt PV of CFt × t
1 /800 /727.27 /727.27
2 800 661.16 1!322.31
3 800 601.16 1!803.16
7 800 '76.71 2!18'.67
' /10!800 /6!70'.9' /33!'29.7'
\$otal /9!271.87 /39!'68.17
Duration is- D = /39!'68.17=/9!271.87 = 7.28171years
b. 1ar ,alue = /10!000 couon rate = 105 < = 105 T= 'years annual aid
t CFt PV of CFt PV of CFt × t
1 /1000 /909.09 /909.09
2 1000 826.7' 1!6'2.89
3 1000 7'1.31 2!2'3.97
7 1000 683.01 2!732.0'
' /11!000 /6!830.13 /37!1'0.67
\$otal /10!000.00 /71!698.6'
Duration is- D = /71!698.6'= /10!000 = 7.1698 years
c. 1ar ,alue = /10!000 couon rate = 125 < = 105 T= ' annual aid
t CFt PV of CFt PV of CFt × t
1 /1200 /1!090.91 /1!090.91
2 1200 991.77 1!983.77
Financial Markets and Institutions
U9824613 阮德龍
3 1200 901.'8 2!707.73
7 1200 819.62 3!278.76
' /11!200 6!9'7.32 /37!771.'9
\$otal /10!7'8.16 /73!829.17
Duration is- D = /73!829.17=/10!7'8.16 = 7.07707 years
Question 2':
Ta*in( the %irst deri,ati,e o% a bondAs rice 91; "ith resect to the yield to \$aturity 9<; ro,ides
the %ollo"in(-
dPPd!1"# = - D
The econo\$ic interretation is that D is a \$easure o% the ercenta(e chan(e in the rice o% a
bond %or a (i,en ercenta(e chan(e in yield to \$aturity 9interest elasticity;. This e#uation can be
re"ritten to ro,ide a ractical alication-
d1 = - D \$d1" B1
3n other "ords! i% duration is *no"n! then the chan(e in the rice o% a bond due to s\$all chan(es
in interest rates! <! can be esti\$ated usin( the abo,e %or\$ula.
Question 30:
)e ha,e the e#uation-
-D = %PP%!1"# =- !&99'(&9)'#&9)'0.'*!1"9.)'+# = - 7.' years
&o! D = 7.' years
Financial Markets and Institutions

Thus.932.074.U9824613 阮德龍 Therefore.976.518. The bond value decreased \$53. • CD: \$82.08. but the current market values and durations are the same.629.89 less than the liability. The assets and liabilities of Bank A change in value by different amounts because the durations of the assets and liabilities are not the same.000.88*PVIFn=7. even though the face values and maturities are the same.67 less than the liability. Therefore.487. and the CD value fell \$54.i=11% + \$1. the maturities of the assets and liabilities are different. b. the change in interest rates causes the same (approximate) change in value for both liabilities and assets. Question 24: Financial Markets and Institutions .362.12. For Bank 2: • Bond: \$1.i=11% = \$839.i=13% = \$840. For Bank B.79. the decrease in value of the asset was \$4.750*PVIFAn=10.43.000*PVIFn=10. the decrease in value of the asset was \$555.

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