Math with Fin Apps (MSF 501)

Assignment 2: Due September 18 by 5 pm

Work in groups with up to 4 people. Write all members names on the first page. Oh yeah, I want hard copy, not an email. 1. Use a spreadsheet to find the durations, modified durations, basis point values and convexities of the following 4 bonds, each with a coupon rate of 6% paid annually, a face value = $1,000, and a yield to maturity of 4.8%. i. ii. iii. iv. 2. 10 year maturity 20 year maturity 40 year maturity 80 year maturity

In problem 1, as maturity doubles, does duration? Why or why not? What happens to convexity has maturity doubles? Consider a butterfly strategy with the following price, duration and CX information (the same as in the notes!).

Devise a position where we are short 20,000 5-year bonds, and long the 2- and 10-year bonds such that i. ii. the butterfly portfolio is immune to small parallel shifts in the yield curve the butterfly portfolio is immune to a twist in the yield curve of, say, a 10 bps increase in the 2-year yield and a 10 bps decrease in the 10-year yield, while the 5-year yield stays at 5.5% (the yield curve is flattening)

a. b. c. 4.

What are the positions (number of 2-year and 10-year bonds) needed to meet these criteria? What is the net value of the butterfly? What is the net dollar-convexity?

What is the duration, modified duration, dollar duration, BPV, and convexity of a 7-year bond that has a coupon rate = 4%, with a yield to maturity = 2.3% and a Face Value = $100,000. If y decreases from 2.3% to 1.9% for the bond in question 4, what is the new price? By how much did the price change in dollar terms? Use the duration approximation to estimate the dollar price change in question 4. Now use the convexity correction. Which estimate is more accurate? [Hint: you better say the one that uses the convexity correction!] A bank funds its assets with $500 million in equity and $4,500 million in deposits and other liabilities. Since A = L + E, we know that the banks assets total $5,000 million. The duration of the liabilities portfolio is 1.5 years, and the duration of the asset portfolio is 3 years. Currently the yields on assets and liabilities are both 4%. a. b. c. What is the implied duration of the equity of the bank? Given your answer in part (a), by how much would equity value change with a 10 basis point increase in yields to assets and liabilities? What would the bank need to do to immunize its equity from shifts in the yield curve?

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