Portfolio (assume annual payments for each bond and mortgage)
Maturity	Type	Annual Coupon/ Mortgage Rate	Face Value of Holdings	Par Value for each Bond
1	Treasury	0	100,000	100
5	Treasury	4%	100,000	100
10	Treasury	5%	100,000	100
10	Mortgage Backed Security	6%	100,000	100
7	B rated Bond	7%	100,000	100

*Mortgage security has a 0% PSA.The mortgage has 10 years remaining at a 6% mortgage rate, face value of loan outstanding of $100,000. Therefore, the borrower pays the investor $13,586.80 per year. The mortgage payments are assumed to be risk-free (insured by FHA).

• Portfolio Values and Risk Management:
  1. Given the discount rates (zero coupon curve) in Q1 above, compute the price of each asset in the portfolio using the asset cash flows through time. Assume that the B-rated bond cash flows are discounted at a spread of 3% to the zero-coupon curve.
  2. Compute the total dollar value of each asset and of the total holdings and weight in each asset.
  3. Compute DV01 and modified duration of each asset and for the entire portfolio. Assume that cash flows to the mortgage do not change with an increase/decrease of discount rates by small amounts.
  4. Discuss in a couple of lines the interest rate risk of the portfolio (using the modified duration).

• Portfolio analysis for potential scenarios: John Garcia is concerned that Jerome Powell is likely to surprise the markets and raise short-term rates by 0.5% (increase in the 1-year zero-coupon treasury rate). He believes this will also decrease 2-year zero-coupon rates by 0.3% and decrease the rest of the zero-coupon term structure by 0.1% (inverted slope of curve). Use the yield curve change rather than duration to assess the following questions.

1. Plot the expected zero-coupon yield curve and the current zero-curve on the same chart to show the shift in rates.
2. How could the portfolio value change from these expected changes? Compute the new $ values and the percent change in each asset and the portfolio using the new zero-coupon curve.
3. Which asset is the most impacted in terms of percentage change in price? Why? Discuss the magnitude of the impact and provide some intuition on the causes of the price change for each asset.

Answer rating: 100% (QA)

To compute the price of each asset in the portfolio we need to discount the cash flows of each asset using the given discount rates zero coupon curve Lets calculate the prices and other relevant metri... View the full answer