Internal Code: MAS7052
Question 1 (10 marks)
An analyst has done a bond valuation and produced the following table for an annual-coupon-paying bond:
1.1 Calculate the holding period return if the bond is held to maturity. (4)
1.2 Calculate the realised compound return of the bond if the bond is held to maturity and coupons are reinvested at 8% per annum.
1.3 Explain the cause of the difference between the yield to maturity and the realised compound return.
Question 2 (8 marks)
An investor has used the traditional valuation approach to value three zero- coupon bonds. The investor analyses the yields on the bonds and concludes that the market has a normal yield curve. The bonds have the following yields and
2.1 Explain one (1) weaknesses of the traditional valuation approach. (1)
2.2 Explain the difference between a normal yield curve and an inverted yield curve. State the conditions that determine the shape of each yield curve in your answer. (4)
2.3 Calculate the forward rate for a one-year zero-coupon bond issued two years from now.
Question 3 (13 marks)
A portfolio is made up of a three-year bond with an annual coupon of 10% and an 8% perpetuity bond. Both bonds have a par value of R100 000 and a yield to maturity of 5%.
3.1 Calculate the Macaulay duration of the three-year bond. (11)
3.2 Calculate the duration of the perpetuity bond.
Question 4 (9 marks)
An investor is analysing the interest-rate risk of a bond. The following table contains information pertaining to the bond:
4.1 Explain the difference between a bond’s duration and convexity. (2)
4.2 Briefly explain why investors prefer bonds with positive convexity. (2)
4.3 Calculate the price value of a basis point for the bond and interpret your answer. (3)
4.4 Calculate the approximate change in the bond’s value if the yield to maturity increases by 25 basis points.
Question 5 (10 marks)
An analyst is researching interest-rate risk and inflation risk in fixed income portfolios. The analyst is considering purchasing an inflation-protected security that pays an annual coupon rate of 10%. The bond has a par value of R100 000 and matures in two years. The following table provides inflation forecasts for the next three years:
5.1 Explain the difference between interest-rate risk and volatility risk. (2)
5.2 Explain why inflation-protected securities might have higher prices than similar non-inflation protected securities. (2)
5.3 Calculate the cash flows of the inflation-protected security. Use a table similar to the one below and show all steps in your calculations.
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