Exam 5: Interest Rate Risk

Use the following information for questions There is a two-period zero coupon bond that will pay $10 million at t = 2.At t = 0, a call option on this bond is selling at $225,000.The holder can exercise the option at t = 1 at a price of $9,250,000.The current yield on a riskless zero coupon bond that matures at t = 1 is 8%.It is known that the yield on one-period bonds at t = 1 will be 6% or 10%.All bonds are identical except in maturity. -What is the payoff to the option holder?

Which of the following statement/s is/are true?

What is the duration of a three-year bond with a 5% coupon rate, a face value of $1,000, and a yield to maturity of 6%? Interest payments are made annually.

What is the usefulness of convexity when duration is available as a measure of interest rate risk? Suggested

The term structure of interest rates:

Duration and maturity are usually_____related, while duration and yield are usually _______ related.

Use the following information for questions There is a two-period zero coupon bond that will pay $10 million at t = 2.At t = 0, a call option on this bond is selling at $225,000.The holder can exercise the option at t = 1 at a price of $9,250,000.The current yield on a riskless zero coupon bond that matures at t = 1 is 8%.It is known that the yield on one-period bonds at t = 1 will be 6% or 10%.All bonds are identical except in maturity. -Suppose that the risk-neutral probability that the interest rate will be 6% is 10%.What is the annualized yield on the two-year bond round up to the nearest figure?

Use the following information for questions There are three zero coupon bonds with a face value of $10 million.One matures one year from now and is selling at $9,433,962.30.The second matures two years from now and is selling for $8,573,388.20.The third matures three years from now and is selling at $7,117,802.50. -What is the yield to maturity of the third bond?

Use the following information for questions There are three zero coupon bonds with a face value of $10 million.One matures one year from now and is selling at $9,433,962.30.The second matures two years from now and is selling for $8,573,388.20.The third matures three years from now and is selling at $7,117,802.50. -What is the implied forward rate between time 1 and time 2?

An inverted yield curve indicates that:

Use the following information for questions A bank has an obligation of $750 at the end of the first period and $550 at the end of the second period.It also has $1,528.93 to invest and can choose between zero-coupon bond or the coupon bond.The coupon bond matures in two years, pays an annual coupon of $100, and has a balloon payment of $1,400.The zero-coupon bond has a balloon payment of $1,610 at the end of the second year.The default-free yield on a one-year bond is 10%, and the annualized yield on a two-year bond is also 10%. -What is the present value of the bank's equity?

Use the following information for questions There are three zero coupon bonds with a face value of $10 million.One matures one year from now and is selling at $9,433,962.30.The second matures two years from now and is selling for $8,573,388.20.The third matures three years from now and is selling at $7,117,802.50. -What is the implied forward rate between time 2 and time 3?

Use the following information for questions A bank has an obligation of $750 at the end of the first period and $550 at the end of the second period.It also has $1,528.93 to invest and can choose between zero-coupon bond or the coupon bond.The coupon bond matures in two years, pays an annual coupon of $100, and has a balloon payment of $1,400.The zero-coupon bond has a balloon payment of $1,610 at the end of the second year.The default-free yield on a one-year bond is 10%, and the annualized yield on a two-year bond is also 10%. -Suppose the interest rate at t = 1 can be 8% or 12%. What will be the bank’s equity if it invests in the coupon bond Ans. $ for 8%; $ for 12%)?

By exactly matching the duration of assets and liabilities, an institution

Use the following information for questions There are three zero coupon bonds with a face value of $10 million.One matures one year from now and is selling at $9,433,962.30.The second matures two years from now and is selling for $8,573,388.20.The third matures three years from now and is selling at $7,117,802.50. -What is the yield to maturity of the second bond?

Financial institutions are interested in duration because

The moral hazard problem created by the institution of the lender-of-last resort facility is

Use the following information for questions A bank has an obligation of $750 at the end of the first period and $550 at the end of the second period.It also has $1,528.93 to invest and can choose between zero-coupon bond or the coupon bond.The coupon bond matures in two years, pays an annual coupon of $100, and has a balloon payment of $1,400.The zero-coupon bond has a balloon payment of $1,610 at the end of the second year.The default-free yield on a one-year bond is 10%, and the annualized yield on a two-year bond is also 10%. -Suppose the interest rate at t = 1 can be 8% or 12%. What will be the bank’s equity if it invests in the zero-coupon bond Ans. $ for 8%; $ for 12%)?

Use the following information for questions A bank has an obligation of $750 at the end of the first period and $550 at the end of the second period.It also has $1,528.93 to invest and can choose between zero-coupon bond or the coupon bond.The coupon bond matures in two years, pays an annual coupon of $100, and has a balloon payment of $1,400.The zero-coupon bond has a balloon payment of $1,610 at the end of the second year.The default-free yield on a one-year bond is 10%, and the annualized yield on a two-year bond is also 10%. -What is the duration of the bank's liability?

Use the following information for questions There are two riskless bonds which mature at t = 2.The first is a zero coupon bond that pays a balloon of $ 1,200.The other is a coupon bond with an annual coupon of $100 and a balloon payment of $990.The current yield on a riskless bond that mature in one year is 10%, the annualized yield on a two-year bond is also 10%. -If the interest rate at t = 1 can be 8% or 12%, what is the percentage price change for the zero coupon bond Answer: change for 8%, change for 12%; round to the nearest figure)?