RSM 430HIS: Fixed Income SecuritiesMidterm Examination - Weight: 35% of final gradeMarch 4th, 2019Time allowed: 1hr 50 minSOLUTIONSLast Name: First Name: Student Number: | _____________________________________________________________________________________________________________________________Instructions:1. Write all of your answers on the examination paper.2. Aids allowed: silent electronic
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RSM 430HIS: Fixed Income Securities
Midterm Examination - Weight: 35% of final grade
March 4th, 2019
Time allowed: 1hr 50 min
SOLUTIONS
Last Name:
First Name:
Student Number: | _________________________________________
__________________________________________
__________________________________________Instructions:
1. Write all of your answers on the examination paper.
2. Aids allowed: silent electronic calculator and one single-sided 8.5”x11”sheet with
formulas and/or notes.
Page 1 of 11
Part A (35 marks) each question is worth 5 marks
Provide brief explanations or answers for the following questions.
1. A bond investor has the following 3 bonds available for investment: The first
bond has a 7% coupon rate and pays interest 2x per year. The second bond has a
8% coupon, and pays interest 12x per year. The third bond has a 8.25% coupon
and pay interest 4x per year. All 3 bonds compound semi-annually. Which of the
3 bonds will provide the investor with the highest effective annual return? Show
all your work.
for bond 1: (1+.07/2)^2 - 1 = 7.122%
for bond 2: (1+.08/2)^2/12 - 1 = 7.866%
for bond 3: (1+.0825/2)^2/4 - 1= 8.167%
bond 3 offers the highest return
2. An investor is considering the purchase of the following: a two-year zero coupon
bond issued by the Royal Bank or a 2 year Royal Bank bond with a 7% coupon
rate. Both bonds are priced to yield 7% and both bonds have a face value of
$1,000. The bond investor wishes to purchase the Royal Bank bond with the
lowest modified duration. Please calculate the modified duration for each bond to
help the investor make his decision. Show all your work.
i) for the Royal Bank zero coupon bond:
macaulay duration for the zero is exactly equal to its maturity date: 2 years
and therefore the modified duration is equal to 2/(1.07/2)= 1.932 %
ii) for Royal Bank 7 % coupon rate bond:
therefore mod. duration for 7% coupon bond = MacD/(1+ytm/2)
=1.901/(1+.07/2) = 1.836%
the coupon paying bond has a lower modified duration
3. Briefly explain the bond call option available to Canadian investment grade issuers
and high yield bond issuers. When explaining the call option for each issuer, please
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be specific regarding the call date the issuer can exercise the option and the exercise
price for the bond
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