exercise

A bond portfolio manager has promised a yield of 12% pa on a three year scheme. The amount to be refunded is Rs.100 cr at the end of the three years. The manager has two bonds to invest in. Bond A and Bond B. What is the relative proportion of money to be invested in the two bonds so that he is immune from IR changes? Show that the portfolio manager is immune to interest changes if the interest rates were to change to 1014%. What would the portfolio adjustments be one year from now and two years from now? Show the new composition of the portfolio for each of the years. Portfolio requirements horizon period (yrs) promised YTM Amount to be refunded (crs) Options Bond A type time to maturity (yrs) YTM on this bond coupon rate face value Bond B type time to maturity (yrs) YTM on this bond coupon rate face value premium on redemption zcb 2 12% 0 100

3 12% 100

with coupon 5 12% 15% 100 17

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exercise

e is immune from IR changes? s were to change to 1014%.

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Instructions

1 2 3 4 5 6 7 8 9

Estimate the amount that is to be invested today so that the desired return is given at the end of three years. Estimate the durations of each of the bonds. Your targeted duration is the portfolio period. The targeted duration is a weighted average of the duration of the two bonds. Estimate the weights of the two bonds. The weights represent the proportion of money to be invested in each of the two bo Show that at the end of three years you will have the desired sum I.e. Rs.100 cr and that this amount will be immune form i The interest rate curve is a flat curve. Show that you will have Rs.100 cr available at the end of the three years if the future rates of interest are 10,11, 12, 13, 14, How will the portfolio composition change after one year I.e. when two years are left for the portfolio to mature?

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Instructions

end of three years.

o be invested in each of the two bonds. this amount will be immune form interest rate shocks.

s of interest are 10,11, 12, 13, 14, 15% respectively for each of the years. he portfolio to mature?

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question

Portfolio requirements horizon period (yrs) promised YTM Amount to be refunded (crs) Options Bond A type time to maturity (yrs) YTM on this bond coupon rate face value Bond B type time to maturity (yrs) YTM on this bond coupon rate face value premium on redemption zcb

3 12% 100

2 12% 0 100

with coupon 5 12% 15% 100 17

Page 5

Portfolio requirements horizon period (yrs) promised YTM Amount to be refunded (crs) Options

3 12% 100 Crores

Solution
Initial investment amount Bond A type time to maturity (yrs) YTM on this bond coupon rate face value Present Value 71.18 Crores

zcb 2 12% 0 100 79.71938776

Duration Of A (DA) Duration Calculation of B Year 1 2 3 4 5

Discount Rate CF 15 15 15 15 132 192.00 4.00107

12% PV 13.39 11.96 10.68 9.53 74.90 120.46 PV X Year 13.39 23.92 32.03 38.13 374.50 481.97

Duration Of B (DB)

Returns After 3 years

Total From Bond A (2 years) From Bond B (3 years) Coupons (end of First year) Coupons (end of Second year) Coupons (end of Third year) 44.66679506 From Reinvesting for 1 year 50.02681047 Price at end of 3 Years 5.556039659 4.960749695 4.429240799 14.94603015 35.02715938 49.97318953

Price Returns Toral Reutrns From B

Total Returns from A+B

100

Bond B type time to maturity (yrs) YTM on this bond coupon rate face value premium on redemption Present Value with coupon 5 12% 15% 100 17 120.46

Weight of A (WA) Weight of B (WB) Duration of A (DA) Duration of B (DB)

0.5003 0.4997 2.0000 4.0011

Amount on A Amount on B No. Of A No. Of B

35.6081 35.5699 0.4467 0.2953

118.622449

Portfolio requirements horizon period (yrs) promised YTM Amount to be refunded (crs) Options

2 12% 100 Crores

Solution
Initial investment amount Bond A type time to maturity (yrs) YTM on this bond coupon rate face value Present Value 79.72 Crores

zcb 1 12% 0 100 89.28571429

Duration Of A (DA) Duration Calculation of B Year 1 2 3 4

Discount Rate CF 15 15 15 132 177.00 3.37647

12% PV 13.39 11.96 10.68 83.89 119.92 PV X Year 13.39 23.92 32.03 335.55 404.89

Duration Of B (DB)

Returns After 3 years

Total From Bond A (1 years) From Bond B (2 years) Coupons (end of First year) Coupons (end of Second year) 51.71498914 From Reinvesting for 1 year 57.92078784 Price at end of 3 Years 4.699636052 4.196103618 8.89573967 Price Returns Toral Reutrns From B 33.18347249 42.07921216

Total Returns from A+B

100

Bond B type time to maturity (yrs) YTM on this bond coupon rate face value premium on redemption Present Value with coupon 4 12% 15% 100 17 119.92

Weight of A (WA) Weight of B (WB) Duration of A (DA) Duration of B (DB)

0.5792 0.4208 1.0000 3.3765

Amount on A Amount on B No. Of A No. Of B

46.1741 33.5453 0.5171 0.2797

118.622449

Portfolio requirements horizon period (yrs) promised YTM Amount to be refunded (crs) Options

1 12% 100 Crores

Solution
Initial investment amount Bond A type time to maturity (yrs) YTM on this bond coupon rate face value Present Value 89.29 Crores

zcb 0 12% 0 100 100

Duration Of A (DA) Duration Calculation of B Year 1 2 3

Discount Rate CF 15 15 132 162.00 2.67526

12% PV 13.39 11.96 93.95 119.31 PV X Year 13.39 23.92 281.86 319.17

Duration Of B (DB)

Returns After 3 years

Total From Bond A (1 years) From Bond B (2 years) Coupons (end of First year) 55.91109276 From Reinvesting for 1 year 62.62042389 Price at end of 3 Years 4.699636052 4.699636052

Price Returns Toral Reutrns From B

33.18347249 37.88310854

Total Returns from A+B

100.50353

Bond B type time to maturity (yrs) YTM on this bond coupon rate face value premium on redemption Present Value with coupon 3 12% 15% 100 17 119.31

Weight of A (WA) Weight of B (WB) Duration of A (DA) Duration of B (DB)

0.6262 0.3738 0.0000 2.6753

Amount on A Amount on B No. Of A No. Of B

55.9111 33.3746 0.5591 0.2797

118.622449