COUGARs Case Study

John Weller
FI 473-002

1. Why have riskless zero-coupon bonds been so successful with investors?

Zero-coupon bonds make it a lot easier for investors to match up the bond maturities with

an event in the future. For example, if you have a certain expense you need to make in the

future, let’s say paying for college, you can set a certain amount of money aside now (in the

form of buying zero-coupon bonds) and in the future you know exacdtly how much money

you will be getting based on that investment. The key aspect of the riskless zero-coupon

bonds is the fact that they are, of course, riskless. Having a guaranteed cash inflow in the

future on an exact date, is great for both personal investors, and also institutional investors

who need to match up any future expenses they know they will be needing to make.

Pension funds, university endowments, etc. would be huge benefactors in these riskless,

zero-coupon bonds.

2. What relationship do the prices of riskless zero-coupon bonds have with the term

structure of interest rates?

Because these treasury bonds are stripped of their coupons, they are treated as if each

coupon is an individual, riskless, zero-coupon bond that expires on the date of the coupon

itself. So in regards to the term structure, each zero-coupon bond will have a larger

discount as time goes on due to the higher inflation and interest-rate risk as time passes.

You can also figure out, forward rates for these zero-coupon bonds by bootstrapping the

different maturities and prices to find the in-between forward rates.

 3. How are spot, strip and coupon yield related?

The coupon yield represents the value of the coupon that is being stripped from the bond

and turned into several different zero-coupon bonds. The yield at which these strips are

trading it is the strip yield, because there are no intervening cash flows, the yield on these

strips is simply the discounted cash flows of the strip itself. From these prices you can also

get the spot yield, which is simply the return on a zero-coupon bond in the future.

4. From the data in the case, reproduce implied spot curve. Compare it against Cougar

Strip curve.

In Exhibit 1, you see the plot of the implied spot curve in blue and the COUGAR strip curve

in red. Some assumptions were taken in to account when creating these curves, mainly the

implied spot curve. Due to the lack of data for a lot of the months, it was hard to get a

strong estimation of what the implied spot curve would look like. The first 5 years or so

were relatively good in that there were a lot of on-the-run bonds that made it easy to

bootstrap yields from. However, as the maturities increased, data became more scarce.

What I decided to do was fill in those months in between with data from the COUGAR strip

curve (the yields were already given since they are zero-coupon bonds), to help bridge the

gap between years. However, I did not include those data points within the implied spot

curve. I simply used the data to get the next data point on the implied spot curve. Without

intervening data to help fill that gap, it wouldn’t be possible to continue the implied spot

curve past about 5 years. Because of this, I don’t see a perfect curve, however I do notice

some clear differences when plotting the implied spot curve against the COUGAR strip
curve. The main feature is that for the first 10 years, about, the COUGAR strip curve had

higher yields than the implied spot curve, but at around 1995, the implied spot curve grows

higher, while the COUGAR strip curve starts to drift down a little. Now, because of the

assumptions made earlier, it is hard to say by how much are the COUGAR strips actually

higher, since we used them in the implied spot curve. The muddling of the data to help fix

the data loss, makes it hard to create any definitive answer.

5. How much value did A.G. Becker Paribas create for itself through the COUGARs

offering? What was the source of this value? (Assume that the T-bill maturing on

December 6, 1983 is trading at 8.11% discount yield on November 16, 1983.)

To find out the value A.G. Becker Paribas created for itself, we need to compare two

different values. One is the cost of buying the Treasury bonds, and the other is the proceeds

he gained from selling all of the individual coupons. The find the cost of the Treasury

bonds, we can do the following:

300,000,000∗.11875
∗(1−1.1189−20 ) = 267,944,275.64
.1189

After finding the cost of the bonds to A.G. Becker Paribas, we can then calculate how much

he sold all of the coupons for. To do this, we first find the value of an individual, semi-

annual coupon on the total bond issuance:

 300,000,000∗.11875
=¿17,812,500
2

However, this is only the value of one coupon at any point in time, and doesn’t reflect the

discount the buyer is getting because these coupons are now zero-coupon bonds. To find

the price paid by the buyer, we can simply multiply the above figure of 17,812,500 by the

individual price of each maturity and add them up, remembering that the Treasury bills

were trading at a 8.11% discount. To do this we can do the following:

∑ Pi∗(1+ .0811∗20
360 )
∗17,812,500

where Pi is equal to the stated price for each maturity in Exhibit 1 of the case. Or, we can

add up all of the individual prices, apply the discount factor and multiply by the nominal

coupon value. This is just a simpler way of doing the above. Adding up all the prices, then

applying the discount yields a “price value” of 15.3052. Taking this and multiplying it by

17,812,500, gives us the proceeds brought in by A.G. Becker Paribas, which are

272,623,875.

So to get the final value created by the firm, we just subtract the outflows from the inflows,

$272,623,875 - $267,944,275.64 = $4,679,599.36. This number is the final value created by

A.G. Becker Paribas.

6. What advice would you give to Ms. Baker? Why?

Ms. Baker would be wise to investigate the COUGARs that are available for the first 5-10

years. These appear to have higher yields than their Treasury counterparts, while the ones

after that, have lower yields that the Treasuries. Because of this difference in the yields, A.G.

Becker Paribas can get the fees associated with selling the COUGARs, while still keeping the

purchasers of the COUGARs at the same, or higher yields than the treasuries. One reason

for perhaps the lower yields in the future is due to the fact that these COUGARs allow for

more flexibility, and perhaps lower interest rate risk, than the Treasuries do. Another nice

feature of the COUGARs package is that it allows for more flexibility in the present as well.

You don’t need to buy a full Treasury bond just to get the semi-annual coupons. By buying

up the COUGARs, however many you want, you can still get the semi-annual coupon feature

without being locked in to a 20-year bond itself.