ACST201 Financial Modelling

Question 1

Take-home quiz 2

S2 2016

[9 marks]

Selina has a portfolio of three Treasury bonds (see table 1).

Table 1: Selinas portfolio
Bond (coupon & maturity)
j2 = 6.5% p.a. 3-year bond
j2 = 5.5% p.a. 2-year bond
j2 = 6% p.a. 2.5-year bond

Yield rate (p.a.)

j2 = 7%
j2 = 6.8%
j2 = 6.7%

a. [3 marks] Calculate the price of each of the three Treasury bonds (per
$100 face value, rounded to 4 decimal places).
b. [3 marks] Calculate the duration of these three Treasury bonds (rounded to 4 decimal places).
c. [3 marks] Calculate the duration of Selinas portfolio of these three
bonds (rounded to 3 decimal places).

Question 2

[14 marks]

Toby is planning to purchase a 5-year j2 = 8% p.a. Treasury bond.

a. [2 marks] Toby is liable for tax at 30% on interest payments only, and
he pays tax immediately when it falls due. Draw a cash flow diagram,
from Tobys perspective, that models this bond purchase scenario.
b. [4 marks] Find Tobys purchase price (per $100 face value, rounded
to 3 decimal places) of this Treasury bond, allowing for 30% tax on
interest only, to give a yield of j2 = 7.5% p.a. (net).
c. [2 marks] Tobys circumstances change. He is now liable for tax at 30%
on interest payments only, and he pays tax six months after the time
of the taxable transaction. Draw a cash flow diagram, from Tobys
perspective, that models this bond purchase scenario.
d. [6 marks] Find Tobys yield, net of tax, as a nominal j2 rate of interest
if his purchase price per $100 face value was $92.554 for this Treasury
bondallowing for 30% tax on interest only, which is deferred one
half-year.

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ACST201 Financial Modelling

Question 3

Take-home quiz 2

S2 2016

[11 marks]

A 10-year j2 = 6.0% p.a. Treasury bond ($100 face value) is purchased at

a yield of j2 = 4% p.a. Assume the investor is able to re-invest all coupon
payments at j2 = 3.9% p.a.
a. [1 mark ] Find the purchase price, rounded to 4 decimal places.
b. [5 marks] Find the total realised compound yield, expressed as a j2
rate and rounded to two decimal places. Include, in your answer, a
cash flow diagram that models the financial circumstances relevant to
your calculation.
c. [5 marks] Find the holding period yield, expressed as a j2 rate and
rounded to two decimal places, if the Treasury bond was held for
exactly eight years (and coupon due on the sale date was received
prior to sale) and the bond was sold at a yield of j2 = 4.75% p.a.
Include, in your answer, a cash flow diagram that models the financial
circumstances relevant to your calculation.

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ACST201 Financial Modelling

Question 4

Take-home quiz 2

S2 2016

[11 marks]

Sam Dastyari is considering investing in a 14% p.a. (j2 rate) Genovian government bond, redeemable at par, maturing in exactly four years.1 Unfortunately, due to problems with the royal succession, there is a lot of political
uncertainty and economic chaos in this once prosperous and peaceful European land.
Sams analysis suggests there is a constant probability of default of 0.049
in any half year. He knows that if the bond defaults he will receive no further
payments at all from the bond.
a. [4 marks] Draw a detailed contingent cash flow diagram, from Sams
perspective, that models the possible financial outcomes over the next
four years.
b. [1 mark ] With reference to your contingent cash flow diagram, give
the probability that, from Sams perspective at t = 0, the bond will
pay its coupon at t = 3 years.
c. [3 marks] With reference to your contingent cash flow diagram, give
the probability that, from Sams perspective at t = 0, the bond will
not pay its coupon at t = 3 years.
This probability is the sum of the probabilities of a variety of different
events. Detail these events, and for each event give its probability.
Finally, show the sum of these probabilities adds to the answer of the
previous paragraph.
d. [3 marks] The current risk-free rate offered by the European Central
Bank is 6% p.a., payable half-yearly. Using the information above,
what should Sam pay for the Genovian bond? (Ignore currency and
other risks not detailed in the question.)

End of quiz

Assume that the government bonds of Genovia have patterns and valuation rules
identical to those of Australian Treasury bonds.