Chapter Ending Questions – Chapter 5 Fabozzi (1,2,9,13,18,19,22)
1b. Treasury rates and the spot rates derived from them represent a the minimum
expected return that would lead investors to forego consumption for a specific time
horizon.
1e.
2 bps, 4 bps.
1d.
Differences in liquidity and any financing advantage in the repurchase market.
3c.
The yield spread of 83 bps. reflects the higher credit risk of AMR relative to
SBTT.
9.
The term structure of interest rates is generally not flat, i.e. the same spot rate for
all times to maturity. Present values of distant cash flows will be penalized most in
present value terms in an upward sloping term structure environment. Present values of
distant cash flows will be penalized least in a downward sloping term structure
environment.
13.
Time to maturity semi-annual
1
2
3
4
5
6
7
8
9
10
11
12
spot rate (z)
5.25%
5.50%
5.76%
6.01917%
6.2822%
6.5495%
6.8213%
7.0985%
7.3815%
7.6712%
7.9684%
8.2740%
b.
$88.8716 per $100 face value
c.
12f1 = 12.4686%
18.
STRIPS are less liquid than the underlying Treasury notes (liquidity premium),
tax treatment of STRIPS (imputed interest), certain non-US investors find corpus STRIPS
attractive due to tax treatment of interest income of these STRIPS in their home country.
b.
Using only coupon strips, the biases would be consistent in terms of liquidity, tax
treatment, and international investor demand factors.
19. Arbitrage forces. A Treasury note that is under priced may be purchase – stripped
and the parts sold for more than the investment. A Treasury note that is over priced my
be sold and STRIPS purchased for less than the revenue received from the sale.
22. See question #2 on Quiz #4.
Chapter 6 (2,6,10,11,12,13)
2.
The real rate is the rate earned above the inflation rate.
b.
Coupon payments are inflation adjusted (index ratio) and return of principal on
the maturity date is also adjusted by the index ratio.
c.
coupon payment = ½ * 3% * 10,000*1.01 =$151.50
inflation adjusted principal = $10,000 * 1.01 = $10,100
coupon payment = ½ * 3% * 10,000 * 1.01 * 1.01 = $153.015
inflation adjusted principal = $10,000 * 1.01 * 1.01 = $10,201
d.
With deflation, the inflation adjusted principal would fall. However the Treasury
has structured TIPS so that they are redeemed (maturity date) at the greater of the
inflation adjusted principal or the initial par value.
e.
The adjustments to principal each year are taxed as a mini-capital gain. This
reduces the attractiveness of TIP investments in non-tax sheltered accounts.
6.
100-day T-bill Bid Price = $89,358.33
100-day T-bill Ask Price = $89,363.89
10.
All Treasury auctions are now single price auctions. In a single price auction all
bidders receiving allotments through the auction receive their bills at the stop-out yield.
11. The day count convention for Treasury securities is actual/actual.
12. Trademark Treasury zero-coupon securities are offered by investment banks who
hold the underlying Treasury notes in a bank custody account. There is a small risk that
the custodian bank may go bankrupt exposing the owner of a Trademark security to some
default risk. Primary Treasury security dealers make a market for Generic receipts
(Treasury receipts ) these were offered to improve the liquidity of the Trademark
Treasury products. Both of these security types require physical delivery of supporting
documentation.
13. STRIPS created through the process operated by the New York Federal Reserve
Bank are the only source of newly created securities stripped from US Treasury notes.