ADM3351-A Assignment 1 (25 points total)

Due 11:59 pm on October 3rd 2023

Weight this assignment is the first of two assignments for the semester. The assignment
is worth 12.5% of your final mark in the course.

Instructions

• Submit this assignment as a single PDF file. Do not submit several photos.
• You can type or handwrite your solution. Either option should be compiled into a
single PDF file.
o For handwritten assignments, scan your pages and combine them into a
single PDF file.
• Feel free to resubmit your assignment before the deadline. Only the last
submitted file will be graded.

Specific assignment instructions

Show your step-by-step work for part marks. Write down the equations you are using.
For problems that you will be using a financial calculator, write down your inputs for
partial marks. Keep at least 4 decimal digits in all your calculation and answers unless
specified otherwise. Make sure your work is legible.

Penalty for late submissions

Students who submit their assignments after the due date will lose 5 points for each
calendar day post due date.
Problem 1 (4 points)

Assume all coupon rates are paid semi-annually. Use face value of $100.

Consider 6-month and 1-year forward rates of r(0.5)=5% and r(1)=6%

Consider 18-month and 2-year spot rates of 𝑟̂(1.5) = 5.3% and 𝑟̂(2) = 6.7%
The price of a zero-coupon bond maturing in 2.5 years from now is $85

a) (1 point) Find the 1-year spot rate 𝑟̂(1)

b) (1 point) Find the 18-month forward rate r(1.5)
c) (1 point) Find the price of a 10% coupon bond maturing 2 years from now
d) (1 point) Find the 2.5 year forward rate r(2.5)

Problem 2 (4 points)

Assume all coupon rates are paid semi-annually. Use face value of $100.

Consider 1-year and 2-year spot rates of 𝑟̂(1) = 6.2% and 𝑟̂(2) = 8.2%
Consider the following bonds:
Bond A: 2-year, 5% coupon bond; fairly priced
Bond B: 2-year, 7% coupon bond; fairly priced
Bond C: 2-year, zero-coupon bond; incorrectly priced at $83

a) (1 point) Calculate bond C’s fair price.

b) (3 points) Find an arbitrage strategy by trading the 3 bonds available to you,
replicating the cash flows from Bond C. How many of each bond will you trade?
Which bonds would you buy or sell?
For reference, fill out the following table:

Buy or Sell Number of Bonds: Of Bond A

Buy or Sell Number of Bonds: Of Bond B

Buy or Sell Number of Bonds: Of Bond C

e.g. BUY 3 Bonds Of Bond X

Problem 3 (5 points)

Assume all coupon rates are paid semi-annually. Use face value of $100.

Assume today’s date is January 31, 2023

Consider 6-month, 1-year, and 18-month spot rates of 𝑟̂(0.5) = 3%, 𝑟̂(1) = 4%, and
𝑟̂(1.5) = 5%

Consider the following bonds:

Bond Maturity Coupon rate

A July 31, 2023 5%

B January 31, 2024 7%

C July 31, 2024 10%

a) (1 point) Find the bond price of bonds A, B, and C.

b) (1 point) Calculate the yield to maturity for each of the bonds (A, B, and C).
c) (1 point) Find the price of Bond B on July 31, 2023, after the coupon is paid.
d) (1 point) Find the price of Bond C on July 31, 2023, after the coupon is paid.
e) (1 point) Find the price of Bond C on January 31, 2024, after the coupon is paid.
Problem 4 (6 points)

Assume all coupon rates are paid semi-annually. Use face value of $1,000.

Consider the following bonds:

Bond Term to Maturity Coupon Rate YTM Face Value

Bond A 3 years 5% 7% $1,000

Bond B 3 years 6% 7% $1,000

Bond C 3 years 7% 7% $1,000

Bond D 5 years 7% 7% $1,000

Bond E 5 years 8% 7% $1,000

Bond F 5 years 9% 7% $1,000

a) (3 points) Calculate the price of each of the bonds. (Bond A, B, C, D, E, and F)

b) (1 point) What relationship do you observe between the yield to maturity, coupon
rate, and price?
c) (2 point) Describe the price activity of a bond as it comes to maturity. Describe a
bond’s yield activity as it comes to maturity. (i.e. does price change as a bond
comes to maturity? How does yield change over time?)

Problem 5 (6 points)

Assume all coupon rates are paid semi-annually. Use face value of $100.

Bond A: 6-month, 2% coupon bond; priced at $103

Bond B: 1-year, 4% coupon bond; priced at $104.5
Bond C: 18 months, 10% coupon bond; priced at $109.3
Bond D: 18 months, 6% coupon bond; priced at $102

a) (3 points) Create a replicate portfolio using bonds A, B, and C to replicate

cashflows from bond D.
 b) (1 point) Is there opportunity for arbitrage? Why or why not?
c) (2 points) Find an arbitrage strategy, replicating the cash flows from Bond D.
How many of each bond will you trade? Which bonds would you buy or sell?
For reference, fill out the following table:

Buy or Sell Number of Bonds: Of Bond A

Buy or Sell Number of Bonds: Of Bond B

Buy or Sell Number of Bonds: Of Bond C

Buy or Sell Number of Bonds: Of Bond D