UBFB3033 FINANCIAL AND MONETARY SYSTEMS

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE

BACHELOR OF BUSINESS ADMINISTRATION (HONS) BANKING AND FINANCE

BACHELOR OF ECONOMICS (HONS) FINANCIAL ECONOMICS

TUTORIAL 3
TOPIC 2: RISK AND TERM STRUCTURE OF INTEREST RATES

1. Discuss the theories that explain the shape of yield curve tend to be upward sloping.

2. You observe the following market interest rates for both borrowing and lending from the
Bloomberg terminal.

Forward rate :10.76%

One-year rate is 8.25% p.a.
Two-year rate is 9.50% p.a.
One-year actual rate one year from now is 11.50% p.a.

How can you take advantage of these rates to earn a risk less profit in the credit market?
Assume the denomination is $1,000,000.

3. Below is the information of bond yield from Bloomberg terminal on May 2nd. 2008.

Three-year $1000 zero coupon bond selling for $776.39.

Four-year 10% coupon $1,000 par bond selling for $1,174.54.
Five-year 8% coupon $1,000 par bond selling for $1,041.29.

What is the implied one-year rate four years from now?

4. If the interest rates on one to five year bonds are currently 4%, 5%, 6%, 7% and 8% and the
term premiums for one to five year bonds are 0%, 0.25%, 0.35%, 0.4% and 0.5%
respectively, predict what is the one year interest rate two years from now.

5. The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%,
13%, 14.5%, 16%, 17.5%. Using the pure expectations theory, what will be the interest rates
on a 3-year bond, 6-year bond, and 9-year bond?

6. Using the information from question 5, now assume that investor prefer holding short-term
bonds. A liquidity premium of 0.1% is required for each year of a bond’s maturity. What will
be the interest rates on a 3-year bond, 6-year bond, and 9-year bond?

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UBFB3033 FINANCIAL AND MONETARY SYSTEMS

7. Economist’s consensus had forecasted one-year Treasury bill rates for the following five
years as follows. You have liquidity premium 0.25% for the next two years and 0.50%
thereafter. Would you be willing to purchase a four-year T-bond at a 5.75% interest rate?

Year 1-year rate

2008 4.25%
2009 5.15%
2010 5.50%
2011 6.25%
2012 7.10%