In a curve trade the idea is to invest in two bonds with different maturities, where...
Fantastic news! We've Found the answer you've been seeking!
Question:
![](https://dsd5zvtm8ll6.cloudfront.net/si.experts.images/questions/2023/03/64003a6482fcf_1677736547289.png)
Transcribed Image Text:
In a curve trade the idea is to invest in two bonds with different maturities, where you are long one bond and short the other, in such a way so as to be unaffected by small parallel shifts of the yield curve (i.e. to be duration-neutral), but to profit from a change in the slope of the yield curve (either flattening or steepening, depending on your view). There is a 2-year bond with coupon rate being 2.3% and a 10-year bond with coupon rate being 2.8%. The continuously compounded yield curve is as below: Maturity 0.5 1 1.5 2 3 4 4.5 5 2.35% 2.38% 2.42% 2.49% 2.66% 2.9% 3.02% 3.42% 5.5 6 6.5 7 7.5 8 8.5 9 9.5 10 Yield Maturity Yield 4.03% 4.50% 5.16% 5.71% 6.38% 6.92% 7.46% 8.07% 8.92% 10.01% a. Calculate the semi-annually compounded yield to maturity for each of the two bonds. From now on, assume that you trade STRIPS rather than the original coupon bond. To express the view that the yield curve will flatten (i.e. that the difference between the 10- year and 2-year interest rates will decrease), which bond do you go long, and which bond do you go short? b. c. Assuming that for the 10-year leg you are long/short (depending on your answer to part(b)) 1000 HKD face value. How many 2-year bonds do you go short/long in order to be duration neutral? 2.5 2.57% 3.5 2.77% d. How much money do you need to invest in this strategy (i.e., borrow to fund the position) or do you receive (i.e., you can then lend out)? e. Approximately how much money do you make per basis point of curve flattening? f. What happens if the interest rates move by the same large (rather than small) amount, say ±2%? Please explain qualitatively what is driving this result. In a curve trade the idea is to invest in two bonds with different maturities, where you are long one bond and short the other, in such a way so as to be unaffected by small parallel shifts of the yield curve (i.e. to be duration-neutral), but to profit from a change in the slope of the yield curve (either flattening or steepening, depending on your view). There is a 2-year bond with coupon rate being 2.3% and a 10-year bond with coupon rate being 2.8%. The continuously compounded yield curve is as below: Maturity 0.5 1 1.5 2 3 4 4.5 5 2.35% 2.38% 2.42% 2.49% 2.66% 2.9% 3.02% 3.42% 5.5 6 6.5 7 7.5 8 8.5 9 9.5 10 Yield Maturity Yield 4.03% 4.50% 5.16% 5.71% 6.38% 6.92% 7.46% 8.07% 8.92% 10.01% a. Calculate the semi-annually compounded yield to maturity for each of the two bonds. From now on, assume that you trade STRIPS rather than the original coupon bond. To express the view that the yield curve will flatten (i.e. that the difference between the 10- year and 2-year interest rates will decrease), which bond do you go long, and which bond do you go short? b. c. Assuming that for the 10-year leg you are long/short (depending on your answer to part(b)) 1000 HKD face value. How many 2-year bonds do you go short/long in order to be duration neutral? 2.5 2.57% 3.5 2.77% d. How much money do you need to invest in this strategy (i.e., borrow to fund the position) or do you receive (i.e., you can then lend out)? e. Approximately how much money do you make per basis point of curve flattening? f. What happens if the interest rates move by the same large (rather than small) amount, say ±2%? Please explain qualitatively what is driving this result.
Expert Answer:
Related Book For
College Physics
ISBN: 978-0495113690
7th Edition
Authors: Raymond A. Serway, Jerry S. Faughn, Chris Vuille, Charles A. Bennett
Posted Date:
Students also viewed these finance questions
-
The idea is to get an equation from the vanishing of the determinant of a homogeneous linear system as the condition for a nontrivial solution in Cramers theorem. We explain the trick for obtaining...
-
The relationship between a bonds yield to maturity and coupon interest rate can be used to predict its pricing level. For each of the bonds listed, state whether the price of the bond will be at a...
-
Yield rates to maturity for zero coupon bonds are currently quoted at 8.5% for one-year maturity, 9.5% for two-year maturity, and 10.5% for three-year maturity. Let i be the one-year forward rate for...
-
The population of a certain colony of bacteria increases by 5% each hour. After 7 hours, what is the percent increase in the population over the initial population?
-
In Prob. 17.74, determine the velocity of each ball relative to the tube as it leaves the tube. Problem 17.74: Two 0.36-kg balls are put successively into the center C of the slender 1.8-kg tube AB....
-
What are some of the causes for the resurgence of countertrade?
-
Describe four ways for a company to deal with risk.
-
Use Appendix B.5 to locate the value of t under the following conditions. a. The sample size is 15 and the level of confidence is 95%. b. The sample size is 24 and the level of confidence is 98%. c....
-
Or the function shown in the graph, list the intervals on which the function is increasing, the tervals on which it is decreasing, and the location of all local extrema. to www List the open...
-
At March 31. Cummins Company had a balance in its cash account of $11.400. At the end of March, the company determined that it had outstanding checks of $1,325, deposits in transit of $790, a bank...
-
What strategies can be employed to foster synergy and collaboration among different departments within the organization ?
-
part 1 of 3 A 150 kg steel rod in a building under con- struction supports a load of 6240 kg. During the day the rod's temperature increases from 23C to 41C, causing the rod to thermally expand and...
-
Analyze the use of nonlinear narrative structures in contemporary literature. How do authors like David Mitchell or Jennifer Egan employ techniques such as time loops and fractured chronology to...
-
The differential equation 8 dx yl/5+ 16x2 y1/5 has an implicit general solution of the form F(x, y) = K. In fact, because the differential equation is separable, we can define the solution curve...
-
Gas in a container is at a pressure of 1.7 105 Pa and a volume of 7.8 m. What is the work done by the gas if it expands at constant pressure to three times its initial volume? Answer in units of J....
-
Clear my choice Question 17 The Bradford Co. has a line of credit with a local bank that permits them to borrow Not yet answered up to $5 million at any time. The interest rate is .43 percent per...
-
2.) Find the Laplace transform of f(t) 7e-St cos 2t +9 sinh2 2t. Use Laplace Table. %3D
-
A 60.0- resistor, a 3.00-F capacitor, and a 0.400-H inductor are connected in series to a 90.0-V (rms), 60.0-Hz source. Find (a) The voltage drop across the LC combination and (b) The voltage drop...
-
The near point of an eye is 75.0 cm. (a) What should be the power of a corrective lens prescribed to enable the eye to see an object clearly at 25.0 cm? (b) If, using the corrective lens, the person...
-
Three charges are arranged as shown in Figure. Find the magnitude and direction of the electrostatic force on the 6.00-nCcharge. 3.00 0.500 m -0.500 m 6.00 nC 0.500 m 2.00
-
During 20XB, Sunflower Energy incurs the following costs relating to Lease A, a producing property: REQUIRED: Determine the tax basis of any assets and the amount of any tax deductions. Supplies for...
-
Tiger Energy has the following information: The lease is subleased to Phil Oil Corporation for $300,000, and Tiger retains an 1/16 ORI. At the date of the sublease, the FMV of the equipment is...
-
Tiger Energy, an independent producer, has average production from Lease A of 100 bbl/ day in 20XA from Lease A. The average selling price of oil in 20XA is $58/ bbl. Net income from Lease A in 20XA...
![Mobile App Logo](https://dsd5zvtm8ll6.cloudfront.net/includes/images/mobile/finalLogo.png)
Study smarter with the SolutionInn App