MTH221R

Timed Online Assignment – January Semester 2021

Principles of Financial Mathematics

Monday, 17 May 2021 4:00 pm – 6:30 pm

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Time allowed: 2.5 hours

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INSTRUCTIONS TO STUDENTS:

1. This Timed Online Assignment (TOA) contains FIVE (5) questions and comprises
SIX (6) pages (including cover page).

2. You must answer ALL questions.

3. If you have any queries about a question, or believe there is an error in the question,
briefly explain your understanding and assumptions about that question before
attempting it.

4. You MUST submit your answers via Canvas (similar to TMA submission) at the
end time of this TOA (as stated on this cover page). The 15 minutes grace period as
shown on Canvas is strictly meant for technical issues encountered during
submission. Thereafter, you will not be able to submit your answers and you will be
considered as having withdrawn from the course. No appeal will be allowed.

5. You are to include the following particulars in your submission: TOA Course Code,
your Full Name, and SUSS PI Number. Name your submission file as
TOACourseCode_FullName_StudentPI. Use underscore and NOT Space. Example:
TOAXYZ_RaphaelLee_T1923161 (omit D/O, S/O).

6. Your submission should consist of only one file and must not exceed 500MB in size.
The file must be a Microsoft Word file saved in .doc or .docx format. All answers are
to be typed. Flowcharts and graphs may be scanned or photographed and embedded
in the Word file provided it does not exceed the file size limit of 500MB.

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TOA – January Semester 2021
7. For answers which cannot be typed and require to be hand-written, ensure that
question number is clearly stated on each page. All uploaded hand written answers
must be clear, readable and complete. Marks will not be awarded for
un-readable or incomplete images.

8. To prevent plagiarism and collusion, your submission will be reviewed by Turnitin.

The Turnitin report will only be made available to the marker and you will not be
able to view it.

9. The University takes plagiarism and collusion seriously, and your Turnitin report will
be examined thoroughly as part of the marking process.

10. Marks will only be awarded if FULL working is shown.

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TOA – January Semester 2021
Answer all questions. (Total 100 marks)

Question 1

Consider the following four bonds of $1,000 face value listed in Table Q1.

Maturity Coupon
Bond Price ($)
(year) Rate
A 0.5 5.4% 1008.84
B 1 6.0% 1019.47
C 1.5 0.0% 935.43
D 2 4.6% 991.20

Table Q1

(a) Describe and calculate the spot rate curve (𝑠0.5 , 𝑠1.0 , 𝑠1.5 , 𝑠2.0 ).
(10 marks)

(b) You have created a portfolio by buying four (4) shares of Bond A, two (2) share
of Bond B and five (5) shares of Bond D. Write down the cash-flow stream of the
portfolio and then calculate the price of the portfolio one year from now.
(10 marks)

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TOA – January Semester 2021
Question 2

A company is obligated to make payments of $30,000 at end of year 1, $20,000 at the

end of year 3, and $50,000 at the end of year 4. To fund these liabilities, the company
intends to purchase appropriate shares of the following two bonds:

Bond A: a 6% coupon bond with 2 years to maturity

Bond B: a zero-coupon bond with 4 years to maturity

Assume that the face values of the bonds are $1,000. (Coupons are paid annually.)

The short rate curve is given in Table Q2.

Year 0 1 2 3 4 5 6
Short Rate (%) 5.0 5.2 5.5 5.9 6.4 6.8 7.3

Table Q2

(a) Calculate the price for each of the two bonds.

(4 marks)

(b) Calculate the quasi-modified duration for each of the two bonds.
(7 marks)

(c) Calculate the present value and the quasi-modified duration of the obligation.
(6 marks)

(d) Discuss and determine the dollar values of Bond A and Bond B to be purchased
respectively, so that a portfolio is formed with the same present value as the
obligation and is immunized against the parallel shifting risk of the short rate
curve.
(3 marks)

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TOA – January Semester 2021
Question 3

Sixteen years ago, you engaged a bank in a 30-year fixed-rate mortgage at 6.3% interest
with monthly payments of $1,764.07.

(a) Solve for the initial principal of the mortgage.

(6 marks)

(b) Due to upexpected economic downturn, you have some difficulty in paying for
the mortgage today. After negotiating, the bank allows you to only pay the interest
due every month for three months. How much interest do you need to pay in total
for the three months?
(6 marks)

(c) After the three months’ sole interest payments, the bank reduces the interest rate
to 4.8%, and you decide to maintain the same level of monthly payments. How
many years in total do you take to pay off the mortgage?
(8 marks)

Question 4

The current and next year’s 1-year spot rates are 4.000% and 6.206%, respectively. The
current 0.5-year discount factor is 0.98232. The 0.5-year forward rates eighteen (18)
months from now is 6.911%.

An investment requires certain initial payment and is promised to have cash payments in
return at future time as listed in Table Q4.

End of year t 0.5 1.0 1.5

X X
Payment ($) X
2 2

Table Q4

(a) Identify the present value of the investment and express it in terms of X.
(14 marks)

(b) Solve for the yield of the investment.

(6 marks)

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TOA – January Semester 2021
Question 5

An 4.8% coupon bond has 20 years to maturity and is currently traded at yield of 5.2%
in the market. Coupons are paid semi-annually and the face value is $1,000.

(a) Examine and calculate the price of the bond.

(3 marks)

(b) Calculate the Macaulay duration of the bond.

(5 marks)

(c) Due to some financial difficulty, it is announced today that the two coupon
payments due in the fifth year will be rescheduled to pay in the seventh year. In
other words, there will be no coupon payments in the fifth year, and coupons will
be paid in double in each of the twice payments in the seventh year. Calculate the
Macaulay duration of the bond after rescheduling the payments.
(12 marks)

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TOA – January Semester 2021