ASSET PRICING

Asset Pricing

Asset Pricing

(a) What will be the current price of bond B?

Price of Bond

=

12

+

12

+

12

+

12

+

12

+

100

(1 + 0.08) ^ 1

(1 + 0.10) ^ 2

(1 + 0.11) ^ 3

(1 + 0.12) ^ 4

(1 + 0.13) ^ 5

(1 + 0.13) ^ 5

Price of Bond

=

12

+

12

+

12

+

12

+

12

+

100

1.08

1.21

1.36763

1.57351

1.84243

1.84243

Price of Bond

=

£ 11.111

+

£ 9.9173

+

£ 8.774

+

£ 7.626

+

£ 6.513

+

£ 54.275

Price of Bond

=

£ 98.218

(b) If you agree today a forward delivery of bond B in two years time from now (h = 2), what will be the theoretical forward delivery price under the current term - structure of interest rates?

Price of Bond

=

12

+

12

+

12

+

100

(1 + 0.08) ^ 1

(1 + 0.10) ^ 2

(1 + 0.11) ^ 3

(1 + 0.11) ^ 3

Price of Bond

=

12

+

12

+

12

+

100

1.08

1.21

1.367631

1.367631

Price of Bond

=

£ 11.11111

+

£ 9.917355

+

£ 8.774296

+

£ 73.11913

Price of Bond

=

£ 102.9219

(c) Without any calculations, indicate how a forward price of bond B for delivery at date 2 will react (increase, decrease or remain at the same level) if the 5 - year spot rate, r 5, fell down by x % and all other spot rates remained unchanged. Provide a brief explanation in no more than 100 words.

The forward price of bond B for delivery at date 2 at date 2 will decrease if the 5 - year spot rate fell down, as the face value of the bond will remain same and the coupon rates will also be same; therefore, the change appear in the par value of the bond will decrease the forward price of the bond B. In addition to this, the price of the bond will decrease as the rate of interest on the bond B has decreased which has made its impact on the price of the bond B that is by decreasing the price of the bond B.

(d) Assume that bank ABC offers a forward borrowing and lending rate of 12 % for forward borrowing in year 3 ...