Scribd Logo
Upload

Welcome to Scribd!

  • B8308 Debt Markets Spring 2011 Problem Set 1 - Reviewing Bond Math

    Uploaded by

    Phil Matricardi
    32 views3 pages
    problem set from columbia business school debt markets class, bonds, financial markets, derivatives. highballs (LSB 54) manipulating the schedule by rushing people out of the store (LSB 41) psychological warfare (F&U 134) sweetener (LSB 52) good cop/bad cop (LSB 54) indirect assessment (LSB 36) snow job (LSB 59) trip wires (F&U 101) developed a decent BATNA (F&U 103) “planned out” (LSB 49) final offers (LSB 46) screen my position (LSB 37) perception modification (LSB 39) bogey, (LSB 55) intimidation? (LSB 57) commitment link with an outside base from the foot traffic (LSB 48) pattern of concessions (LSB 44) assume the close (51) initial concession (LSB 42) refusing to negotiate (F&U 138) resistance point (LSB 35) ambiguous authority figure (F&U 132) calculated delay (F&U 141) attempting to modify or call attention to the other side’s BATNA (F&U 104) manipulate the cost of delay (LSB 39) negotiate the rules of the game (F&U 130), Phil Matricardi Financial Markets and the Economy Problem Set 5 3. An unanticipated decline in the price level deteriorates firms’ net worth by increasing the burden of their indebtedness, making them less able to lend. This is due to the common practice of long term fixed-rate borrowing; in a deflationary environment, these liabilities increase in real value, while assets remain anchored in nominal value. 4. A decline in real estate prices affects the value of assets used as collateral. Collateralized loans like mortgages, MBS, and CDOs backed by either one also decline in value. The decline in collateral has a proportionate affect on the amount of available credit. The decline also increases financial frictions, dries up liquidity and necessitates deleveraging. 6. After the failure of a major financial institution, short term lending rates increase dramatically due to the expectation that other similar firms may have similar catastrophic problems. In the increased rate environment, only truly desperate firms will be willing to borrow, while healthy firms will stay on the sidelines. Moreover, troubled firms have an incentive to use high-rate loans to gamble on their continued survival—it doesn’t matter how much they have to pay, because even a bad chance of survival due to a high rate loan is better than their current prospects. 8. Governments with bad fiscal imbalances can see the rate of interest on their debt in the market climb steadily. This should lead them to curb their spending, but often they instead turn to domestic banks and use their power as regulators, connections, direct power over the banks or other forms of pressure to get the bank to buy their debt. When investors see that the govt. is able to borrow undisciplined by the market, they may sell their bonds, decreasing the price, and causing large losses for the banks holding them. This in turn causes an increase in financial frictions. 10. Weak financial regulation and supervision can allow financial institutions to make bad loans, where borrowers’ creditworthiness is exaggerated or falsified. Relaxed regulation can also lead to large foreign capital inflows. Both of these lead to a lending boom, which eventually ends in a crash and crisis. 14. When financial intermediaries originate loans knowing that they will be able to sell them off in the near term, it decreases their incentives to do expensive due diligence on borrowers and to forgo risky loans. When it comes time to sell the loan, the institution is likely to trade on its good name and keep the buyer uninformed about the real risk in the loan. It will do this out of ignorance if it truly does not know that the loan is bad, and as a matter of survival if it knows that it must get it off its books before the bust comes around. 18. During a financial crisis, the value of collateral (agency debt, for example) can become much more volatile or decline in value. This decreases its desirability and leads lenders to require a much

    Original Title

    ps1

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document
    problem set from columbia business school debt markets class, bonds, financial markets, derivatives. highballs (LSB 54) manipulating the schedule by rushing people out of the store (LSB 41) psychological warfare (F&U 134) sweetener (LSB 52) good cop/bad cop (LSB 54) indirect assessment (LSB 36) snow job (LSB 59) trip wires (F&U 101) developed a decent BATNA (F&U 103) “planned out” (LSB 49) final offers (LSB 46) screen my position (LSB 37) perception modification (LSB 39) bogey, (LSB 55) intimidation? (LSB 57) commitment link with an outside base from the foot traffic (LSB 48) pattern of concessions (LSB 44) assume the close (51) initial concession (LSB 42) refusing to negotiate (F&U 138) resistance point (LSB 35) ambiguous authority figure (F&U 132) calculated delay (F&U 141) attempting to modify or call attention to the other side’s BATNA (F&U 104) manipulate the cost of delay (LSB 39) negotiate the rules of the game (F&U 130), Phil Matricardi Financial Markets and the Economy Problem Set 5 3. An unanticipated decline in the price level deteriorates firms’ net worth by increasing the burden of their indebtedness, making them less able to lend. This is due to the common practice of long term fixed-rate borrowing; in a deflationary environment, these liabilities increase in real value, while assets remain anchored in nominal value. 4. A decline in real estate prices affects the value of assets used as collateral. Collateralized loans like mortgages, MBS, and CDOs backed by either one also decline in value. The decline in collateral has a proportionate affect on the amount of available credit. The decline also increases financial frictions, dries up liquidity and necessitates deleveraging. 6. After the failure of a major financial institution, short term lending rates increase dramatically due to the expectation that other similar firms may have similar catastrophic problems. In the increased rate environment, only truly desperate firms will be willing to borrow, while healthy firms will stay on the sidelines. Moreover, troubled firms have an incentive to use high-rate loans to gamble on their continued survival—it doesn’t matter how much they have to pay, because even a bad chance of survival due to a high rate loan is better than their current prospects. 8. Governments with bad fiscal imbalances can see the rate of interest on their debt in the market climb steadily. This should lead them to curb their spending, but often they instead turn to domestic banks and use their power as regulators, connections, direct power over the banks or other forms of pressure to get the bank to buy their debt. When investors see that the govt. is able to borrow undisciplined by the market, they may sell their bonds, decreasing the price, and causing large losses for the banks holding them. This in turn causes an increase in financial frictions. 10. Weak financial regulation and supervision can allow financial institutions to make bad loans, where borrowers’ creditworthiness is exaggerated or falsified. Relaxed regulation can also lead to large foreign capital inflows. Both of these lead to a lending boom, which eventually ends in a crash and crisis. 14. When financial intermediaries originate loans knowing that they will be able to sell them off in the near term, it decreases their incentives to do expensive due diligence on borrowers and to forgo risky loans. When it comes time to sell the loan, the institution is likely to trade on its good name and keep the buyer uninformed about the real risk in the loan. It will do this out of ignorance if it truly does not know that the loan is bad, and as a matter of survival if it knows that it must get it off its books before the bust comes around. 18. During a financial crisis, the value of collateral (agency debt, for example) can become much more volatile or decline in value. This decreases its desirability and leads lenders to require a much

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    32 views3 pages

    B8308 Debt Markets Spring 2011 Problem Set 1 - Reviewing Bond Math

    Uploaded by

    Phil Matricardi
    problem set from columbia business school debt markets class, bonds, financial markets, derivatives. highballs (LSB 54) manipulating the schedule by rushing people out of the store (LSB 41) psychological warfare (F&U 134) sweetener (LSB 52) good cop/bad cop (LSB 54) indirect assessment (LSB 36) snow job (LSB 59) trip wires (F&U 101) developed a decent BATNA (F&U 103) “planned out” (LSB 49) final offers (LSB 46) screen my position (LSB 37) perception modification (LSB 39) bogey, (LSB 55) intimidation? (LSB 57) commitment link with an outside base from the foot traffic (LSB 48) pattern of concessions (LSB 44) assume the close (51) initial concession (LSB 42) refusing to negotiate (F&U 138) resistance point (LSB 35) ambiguous authority figure (F&U 132) calculated delay (F&U 141) attempting to modify or call attention to the other side’s BATNA (F&U 104) manipulate the cost of delay (LSB 39) negotiate the rules of the game (F&U 130), Phil Matricardi Financial Markets and the Economy Problem Set 5 3. An unanticipated decline in the price level deteriorates firms’ net worth by increasing the burden of their indebtedness, making them less able to lend. This is due to the common practice of long term fixed-rate borrowing; in a deflationary environment, these liabilities increase in real value, while assets remain anchored in nominal value. 4. A decline in real estate prices affects the value of assets used as collateral. Collateralized loans like mortgages, MBS, and CDOs backed by either one also decline in value. The decline in collateral has a proportionate affect on the amount of available credit. The decline also increases financial frictions, dries up liquidity and necessitates deleveraging. 6. After the failure of a major financial institution, short term lending rates increase dramatically due to the expectation that other similar firms may have similar catastrophic problems. In the increased rate environment, only truly desperate firms will be willing to borrow, while healthy firms will stay on the sidelines. Moreover, troubled firms have an incentive to use high-rate loans to gamble on their continued survival—it doesn’t matter how much they have to pay, because even a bad chance of survival due to a high rate loan is better than their current prospects. 8. Governments with bad fiscal imbalances can see the rate of interest on their debt in the market climb steadily. This should lead them to curb their spending, but often they instead turn to domestic banks and use their power as regulators, connections, direct power over the banks or other forms of pressure to get the bank to buy their debt. When investors see that the govt. is able to borrow undisciplined by the market, they may sell their bonds, decreasing the price, and causing large losses for the banks holding them. This in turn causes an increase in financial frictions. 10. Weak financial regulation and supervision can allow financial institutions to make bad loans, where borrowers’ creditworthiness is exaggerated or falsified. Relaxed regulation can also lead to large foreign capital inflows. Both of these lead to a lending boom, which eventually ends in a crash and crisis. 14. When financial intermediaries originate loans knowing that they will be able to sell them off in the near term, it decreases their incentives to do expensive due diligence on borrowers and to forgo risky loans. When it comes time to sell the loan, the institution is likely to trade on its good name and keep the buyer uninformed about the real risk in the loan. It will do this out of ignorance if it truly does not know that the loan is bad, and as a matter of survival if it knows that it must get it off its books before the bust comes around. 18. During a financial crisis, the value of collateral (agency debt, for example) can become much more volatile or decline in value. This decreases its desirability and leads lenders to require a much

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 3

    B8308 Debt Markets Spring 2011 Problem Set 1 Reviewing Bond Math Do not turn this in; answers

    s will be posted on or about Mon 14 Feb. 1. GE Capital issues $500 million principal amount of 3.50% Notes due in exactly five years. At pricing, the benchmark 5-yr T-note has a YTM of 2.523%, and the issue is sold to investors at a yield spread of 105 basis points over the 5-yr T-note. (a) What is the investors yield to maturity on the notes? (b) What price does the investor pay at issuance (as a percentage of par, calculated to three decimals)? (c) An investor agrees to buy $10 million face. How much does he wire over to buy bonds? (d) Assume that, six months later, the Notes are trading at 102. Based on a six month holding period, what would be your annualized total return on the Notes if you bought them at issuance? 2. You can buy a zero coupon domestic corporate bond of the Ziv Corporation that matures in ten years at a price of 50.835%. What yield does the bond offer? 3. The XYZ Corporation has two outstanding bond issues that mature exactly 10 yrs from now: XYZ Eurobonds have a 6.25% coupon, paid annually, and trade at a price of 99.125. XYZ domestic bonds have a 6.10% coupon, paid semiannually. (a) What is the bond equivalent yield on the Eurobonds? (b) If the other features of the two bond issues are identical and markets are efficient, what should be the price of the domestic bonds? 4. It is January 20, 2005, and the FannieMae 4.375% due 7/17/2013, which has a one-time call at par on 7/17/2006, is trading at 97.944. (a) What is the current yield (= coupon / quoted price) on this instrument? Is the current yield a useful number? (b) If you buy this bond today (Thu Jan 20), it will settle on Fri Jan 21. How much accrued interest will you pay? (c) What is the yield-to-worst on this bond? 5. Suppose that it is Tue 22 Jan 2008. Youve been instructed to put on a 2-yr/10-yr yield curve trade that calls for a long position of $50 million (market value) in the 4.25% T-note due 15 Nov 2017 at a quoted price of 105:26+ and a yield of 3.541%, and a $50 million short position (market value) in the 3.25% T-note due 31 Dec 2009 at a quoted price of 102:04+ and a YTM of 2.116%. You will use repos or reverse repos to take both positions. You can borrow money in the repo market at a repo rate of 4.75%, and you will lend at a repo rate of 3.00%, due to the specialness of the 10-yr T-note. Assume that haircuts are zero.

    B8308 Debt Markets Spring 2011

    Problem Set 1

    (a) How many (i.e., what face value) of each bond do you need? Remember that settlement is one business day later. (b) What is the daily carry on this trade, including all the repo components? Is it positive or negative? (c) Evaluate this trade on Feb 5 (for settlement on Feb 6). On that date, the 10-yr has a quoted price of 105-17+ and the 2-yr is quoted at a price of 102-15. Whats the profit or loss? What happened? 6. Convertible bonds typically give the holder the option to redeem her bonds for a fixed number of common shares. Which should have the higher yield: a convertible bond or an otherwise identical bond without a conversion feature? Explain. 7. Consider Air Products 4.375% notes due August 21, 2019. These bonds have what is known as a make-whole call. This means that the issuer has the option to redeem the bonds at any time, but has to pay a higher price if interest rates have fallen. This higher price makes the investor whole, i.e., ensures that she is not disadvantaged by the redemption. Specifically, to redeem the bonds, the issuer must pay the greater of (a) par, or (b) a price that would give the bonds a yield-to-maturity equal to that of a comparable Treasury plus a make-whole yield spread (15 bps in the case of this issue). The issuer must also pay accrued interest. For example, if there are three years left to maturity and 3-yr T-notes have a yield of 5.00%, the Air Products bonds would be callable at a (quoted) price to give them a YTM of 5.15%. Suppose it is now August 21, 2012. Assume that the Treasury yield curve and Air Products new issue spreads on that date are as follows: Treasury Air Products new issue Maturity YTM all-in yield spread 2 years 2.03% 70 bps 3 years 2.60% 90 bps 5 years 3.41% 110 bps 7 years 4.10% 120 bps 10 years 4.63% 130 bps (a) If the bonds are called to settle on this date, what is the quoted call price? The invoice price? (b) Given these yield curves, should Air Products issue new 7-year bonds to refinance the 4.375s due 2019? Focus just on the economics given here. Ignore taxes and any other strategic reason why youd call the bonds. 8. You are working on the debt capital markets desk at Deutsche. It is 7 Feb 2008, and the desk has just priced a $1.5 billion issue of 4.25% IBM notes at 99.939 (which means that, until it is actually sold to investors, the underwriter technically owns it all). The IBM notes are due in exactly 5 years. At the time the IBM notes were priced, two T-notes were trading at the following levels (for settlement on 10 Feb 2008): Price YTM T-note 2.875% due 31 Jan 2013 100:27+ 2.69% 3.500% due 15 Feb 2018 98:24 3.65%
    B8308 Debt Markets Spring 2011 2 Problem Set 1

    (a) List two ways that Deutsche can hedge its long position in IBM debt. Which of these is likely to provide the better hedge, and why? (b) How many 5-yr T-notes (i.e., what face value) do you need to short in order to hedge the IBM debt position? 9. You are considering the following on-the-run vs. off-the-run trade: Quoted Price Face T-bond (T+1 is 02/15/2008) Side Long $100 mm 4.375% due 02/15/2038 98:18 Short $100 mm 5.000% due 05/15/2037 108:25 (a) What is the DV01 of each half of the trade? (b) What is the overall DV01 of the position? (c) Are you hedged against parallel shifts in yields? Explain. 10. Which has the smaller modified duration, and why? (a) an 8% coupon bond with 20 years to maturity selling at par (b) an 8% coupon bond with 20 years to maturity selling below par 11. Which has the smaller effective (modified) duration, and why? (a) a noncallable bond with a 10-year maturity trading at par (b) a 10-year bond callable at par after 3 years trading at par

    4-wk term Repo Rate 1.50% 2.70%

    B8308 Debt Markets Spring 2011

    Problem Set 1

    You might also like