FINS2624 Portoflio Management

One-year spot rate:

10
107.42
1.05

Two-year

spot

rate:

1=6

Three-year spot rate:

100
1=5
95.24

0.5

110

100
85.48

Kai Lin z3411977

120
20
20
140.51

1.05 1.062

(13 )1=5

Four-year

spot

rate:

0.25

1=4

25
125
( 1.05
)+( 1.06
)=23.81+ 22.25+89.00=135.06
2

Sell the bond on market for $136.

1+Y 1
110
=105.6
Bond X 10/()+
( 1+Y 2 )2

1+Y 1
120
=123.86
Bond Y 20/()+
( 1+Y 2 )2

Y1=5% Y2=7%

Solving both equation simultaneously and obtain:

FINS2624 Portoflio Management

Kai Lin z3411977

If the investment horizon is one year, the bond is two years, then the risk is liquidity
risk.
If the investment horizon is three years, then the risk is reinvestment risk.

t s

( 1+ y s ) ( 1+ s f t ) =( 1+ y t )

t t s

( 1+ y t )
1+s f t =
s
( 1+ y s )

1+7
(0.5)
( 3/(1+5 )) 1=8
a. E ( 1 y 3 )=

( 1+ y t )
( 1+s f t ) =
s
( 1+ y s )
t s

t t s

( 1+ y t )
s f t=
s
( 1+ y s )

b.

100
( 1+ 5 ) =93.45
( 1+6 )2

From the given forward rate, the spot rate can be calculated as: Y 1=0 f 1=7

FINS2624 Portoflio Management

( 1+ 9 )
( 1+7 )

Y 2=
1

Y 3=( ( 1+7 ) (1+ 9 )( 1+10 ) ) 3 1=8.66

10
10
110
+
+
=103.66
Hence the bond price will be:
2
1.07 1.08 1.08663

Kai Lin z3411977