Interest Rate Risk Question

FINANCIAL INSTITUTIONS MANAGEMENT

TOPIC 5 – INTEREST RATE RISK

TEAM QUESTIONS

1. Complete Table 1, regarding Australian Government Treasury Bonds maturing in April 2012 and April 2020, based on yields for any business day prior to your tutorial. (See the Pre-tutorial Questions for instructions on how to get these yields.) These bonds have a face value of $1,000. All Treasury bonds mature on the 15th day of the month of maturity. Don’t forget to make all necessary adjustments for semi-annual coupon payments. For simplicity, the duration and current price of both bonds should be calculated as at 15 April 2011 (i.e. assume that the coupon payment due on that date have just been paid). Table 1 Maturity date April 2012 April 2020 Coupon rate 5.75% 4.50% Current yield Current price Duration (years)

2.

Recalculate the price of the bonds following a decrease in the yields of 0.01%, and complete Table 2. The percentage change in price should be expressed to 4 decimal places. It is not necessary to use a spreadsheet to recalculate the price of the 2020 bond. This can be done using the following formula:  1  1  r  n  FV  P C n r   1  r    where C is the semi-annual coupon payment, r is the semi-annual yield, n is the number of coupon payments and FV is the face value. Table 2 Maturity date April 2012 April 2020 Coupon rate 5.75% 4.50% Decreased yield Revised price Percentage change

FIN3FIM – Financial Institutions Management

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Team Questions Topic 5

3.

Comment on the difference between the percentage changes in the two bonds. Which bond has the larger percentage change in value? Why?

4.

Estimate the expected percentage changes in the prices of these bonds following a decrease in the yields of 0.01%, using duration instead of recalculating the price. The formula you require is: D P  r 1  r  P Table 3 Maturity date April 2012 April 2020 Duration (years) Initial yield (r) Change in yield (Δr) 0.01% 0.01% Estimated...