Consider two zero-coupon bonds with 2 years and 10 years to maturity. Let a = 0.2, b

Question:

Consider two zero-coupon bonds with 2 years and 10 years to maturity. Let a = 0.2, b = 0.1, r = 0.05, σVasicek = 10%, and σCIR = 44.721%. The interest rate risk premium is zero in each case. We will consider a position consisting of one $100 2-year bond, which we will hedge with a position in the 10-year bond.
a. Compute the prices, deltas, and gammas of the bonds using the CIR and Vasicek models. How do delta and gamma compare to duration and convexity?
b. Suppose the Vasicek model is true. You wish to hedge the 2-year bond using the 10-year bond. Consider a 1-day holding period and suppose the interest rate moves one standard deviation up or down. What is the return on the duration-hedged position? What is the return on the Vasicek delta-hedged position?
c. Repeat the previous part, only use the CIR model in place of the Vasicek model. Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...