BUS288 Test Practice Questions____________

5. 90-day bank bills with face values of $100,000 are priced to yield 6.25% p.a. If bank interest
rates are 5% p.a. (compounded daily), identify an arbitrage opportunity.

6. If a 180-day bank bill yields 6.5% and a 360-day (pure discount) bank-bill yields 7.0%, what is
the no-arbitrage price of a 1-year bond with a face value of $1,000 and coupon rate of 6% p.a.
paid semi-annually? (Assume a 360-day year.)

7. Supposing the bond in question 6 had a market price of $980.00, outline the arbitrage
opportunity may be exploited.

8. What round-trip profit is available in question 7.

9. Describe how the bond and bill prices in question 7 will adjust to enforce the law of one price.
10. An Australian investor is looking for an arbitrage opportunity. Assuming this investor has
AUD450 available (and cannot borrow additional funds) calculate the amount of profit that can
be made. Give your answer in Australian dollars and cents to the nearest cent.

11. A two-year zero-coupon bond rate is quoted at 7.9% pa effective and the one-year zero
coupon bond rate is quoted at 7.2% pa effective. Furthermore, the one year forward, one-year
yield rate is quoted at 8.605% pa effective.

Assume that arbitrage profits of less than $0.0001 per dollar are negligible and can be ignored.
Based upon the given information is there:

A) an arbitrage opportunity
B) no arbitrage opportunity
C) we require more info

12. A bond has 12% annual coupons, a 3-year maturity, and a face value of 1000. The interest
rates are 10%, 9% and 8% over successive years. What is the market value?

What is the three-year bond yield for Q12?

What is the geometric average rate, or the zero rate for Q12?

If the bond value were to be invested at this zero rate, what would the investor receive in
dollars?
13. The current risk-free zero-coupon interest rates are as follows:

Year to Maturity Interest rate % p.a.

1 6%
2 6.5%
3 6.9%
4 7.2%
5 7.4%

a) Assume that the term structure can be explained purely by expectations of the future interest
rates, and therefore there is no liquidity or risk premium. Calculate the expected 1-year interest
rates for the next 4 years.

b) Explain why it is not possible in this market for the 6-year zero coupon interest rate to be 6%
per annum.
14. If the one-year spot interest rate is 10%, and one-year interest rates are expected to be 11%
p.a. and 12% p.a. in one and two years times respectively, what would be the yield to maturity
on a three-year pure discount bond?

15.. If a pure discount three-year bond sells for $782 and a pure discount four-year bond sells
for $733, what is the expected 12-month interest rate in three years time? Both have a face
value of $1000.

16. Twelve-month interest rates for the next four years are expected to be 5%, 6%, 6.8% and
7.4% respectively.
Calculate the yield to maturity on:
i) a pure discount four-year bond, and

ii) a four-year 8% annual coupon bond. Explain why there is a difference.

17. An investor purchases the following debt instruments with a $1,000 face value, for $826.44
and $1,000 respectively.
i) a pure discount two-year bond, and
ii) a two-year 10% annual coupon bond
Calculate the return after two years if immediately after purchase interest rates
a) fall by 1% p.a.

b) remain constant, and

c) increase by 1`% p.a. on all maturities.

18. An investor wants to make a two-period investment and is presented with the following
investment options:
(a) Invest for one period at 3.16% pa and then for a further single period at 3.02%.
(b) Invest for two periods at 3.15% pa.
Select the investment option that should be chosen to maximize the return. Assume that the
interest rates are compound interest rates. Round all percentage calculations to 2 decimal
places.

19.

ia,b Interest rate

One period spot rate i0,1 8.6%pa
One period forward rate i1,2 4.95%pa
Three period spot rate i0,3 10.05%pa

Calculate the one year forward rate two years from now.
Duration____
1. Calculate the PV of a 5 year, FV $1000 bond with 10% semiannual coupons.

2. What is the duration of a bond with 10% p.a. semiannual coupons, 5-year maturity, with a
face value of $1000? Interest rates are 6%. Duration must be in years.

3. A manager invests in the following and plans to liquidate in 3 years.

- 600 two-year discount bonds with a $1000 FV and YTM of 6% – duration is 2 years
- 400 five-year bonds were YTM is 6%, 50 PMT, 1000FV – duration is 4.14 years

Show the duration of this portfolio matches the investment horizon

Two-year bonds have a market value of $888.49
Five-year bonds have a market value of $1170.60

a) Show that the duration of the portfolio is in fact 3 years. (Hint use Dp formula)

b) Suppose that immediately after the investment was made, interest rates fell to 5 p.a. (Hint:
the two year bonds will be invested at 600,000 x 1.0252 (3 years) – as 2 represents 3 years, as
its 3 periods from 0).
(Hint: find the value that the coupons could be reinvested for at the new rate. Note the duration.
Also find the new market value of the bond (NOTE the new maturity after duration) – and how
much they could all be sold for.)
i) What is the total cash flows after the liquidation date of 3 years?

ii) Show the rate of return in p.a. (convert from semiannual)

(Vn / Vo)1/n – 1

4) A bond has a FV of $100, yield is 9% p.a, bonds pay annual coupons of 10%. The term to
maturity is 2 years.
i) Calculate price of the bond

ii) Calculate duration of bond

5) A bond pays 10% coupons annually, has a FV of $100, interest rates are 8.5%. The term to
maturity is 3.5 years. Calculate the duration. (hint: last row period should be 3.5 year)

6) A financial instrument provides three future cash flows:

1. 2782.82 at the end of 3 years

2. 2582.37 at the end of 7 years.
3. 1412.65 at the end of 11 years.
(Hint: you can use table). Note the year terms.
CF# Term(year) CF PV CF T*PV