Question 1 [6 marks]

a. [1 mark ] Find the price (per $100 face value, rounded to 3 decimal

places) of a 12% Treasury bond, 145 days before maturity, at a yield

of 6.26% p.a. 1

b. [2 marks] Suppose another student sees your answer to a., and says

"You're wrong! Your answer is more than $100. The price

of a short term financial instrument should be always less

than its face value!"

Explain to this student why the price of the Treasury bond in a. is

greater than its face value of $100.

c. [3 marks] Consider the bond in a., but rather price it 187 days before

maturity at a yield of 6.24% p.a. Here, a coupon payment is made

on the fifth day and the last day. Draw a cash flow diagram that

represents this scenario to accompany your answer.

Question 2 [11 marks]

a. [5 marks] Find the price (per $100 face value, rounded to 3 decimal

places) of a 10-year 10% Treasury bond, allowing for 30% tax on in-

terest only, to give a yield of j 2 = 8% p.a. (net). Draw a cash flow

diagram that models this scenario to accompany your answer.

b. [2 marks] Explain how, and why, the price you calculated in a. would

change (up or down) if allowance was made for tax on capital gains as

well as on interest. Do not do any further calculations. Assume that

the net yield and tax rate have the same values as in a.

c. [2 marks] If the bond in a. sold for $92.411 per $100 face value, use an

approximate formula (like the bond salesperson's method) to calculate

the yield ( j 2) to maturity.

d. [2 marks] Repeat c. above, but use linear interpolation.

1Note that an Australian Treasury bond, in the period between its penultimate and

last coupon payment, is priced using simple interest.