Question 1 30
A corporate bond is a type of debt instrument that is issued by a corporation to raise capital. It is a fixed-income security that obligates the issuer to pay the bondholder a specified amount of interest over the life of the bond and to repay the principal (face value) of the bond when it matures.
The maturity of a corporate bond refers to the length of time until the bond reaches its final payment date and the principal is repaid to the bondholder. Maturity can range from a few months to several decades, depending on the terms of the bond.
There are several factors that can influence the maturity of a corporate bond, including the issuer’s financial condition and creditworthiness, market conditions, and the issuer’s need for capital. For example, a financially stable issuer with a good credit rating may be able to issue a bond with a longer maturity, while a less creditworthy issuer may need to issue a bond with a shorter maturity in order to attract investors.
Corporate bonds with longer maturities generally carry higher levels of risk for the investor, as there is a greater possibility of changes in market conditions or the issuer’s financial condition over a longer period of time. As a result, these bonds typically offer higher yields to compensate for this added risk. On the other hand, corporate bonds with shorter maturities tend to carry lower levels of risk and offer lower yields to investors.
a) Please choose a corporate bond with a maturity of at least two years. Possible sources include Fidelity, Morningstar or other similar services or if you do not have an account, then you can use
http://finra-markets.morningstar.com/BondCenter/Default.jsp
However, you can choose any other source as well, but make sure you let me know where your data comes from.
Also, please find a comparable treasury (using for example, treasury.gov Bloomberg or other sources or the Finra website above).
a) First, assume annual coupons for simplicity and calculate the duration and convexity of your bond.
b) What would the realized compound yield on your bond be at maturity if the market yield for the bond dropped by 2% immediately (do not worry about fractional years, assume that the drop affects reinvested coupons starting with the next coupon).
c) Using the comparable treasury rate as the risk-free rate, please do the following based on class discussion. Assume annual coupons and that the bond may only default at maturity. When it matures can either pay the promised payment or default and pay only principal, with no interest. What is the probability of that occurrence? If you cannot find probabilities that will be compatible with the current prices explain why this is the case. If an analyst suspects that the analysis above is flawed, and that the bond may also default prior to maturity, should they buy or sell the bond?
Question 2 15
a) Please consider the treasury yield curve below. Also, see the class list below arranged alphabetically. We move left from to right and then down, so that the first cell is 1 month at 12/01 the second is 2 months at 12/01 and so forth. The first person on the list, chooses the first cell and the next one the second person chooses the second cell and the third one and so on. Once your find your cells, please calculate the yield the market expects on a short bond in the next period based on the long term and short-term rates in the two cells and the unbiased expectations hypothesis. Are these two yields consistent also with the liquidity premium hypothesis? The market segmentation hypothesis?
Question 3 25
Below is a link to NY Municipal bonds. Please choose a bond that has a maturity closer to your birthday (for example, if your birthday is on the 1st of the month, choose a one-year bond, if it is the 30th choose a 30-year bond). However, make sure that you choose a bond with a maturity that corresponds to a treasury maturity- for example, if your birthday is on the 6th, choose a bond with 5 year maturity, since the treasury does not issue 6 year bonds. Please compute the taxable equivalent yield on the municipal bond assuming a 35% federal tax and 12% combined state and city tax. Compare to this to the taxable equivalent yield on an equivalent treasury (keep in mind that you do not pay state or local tax on treasury interest but you do pay federal taxes). Also compare to corporate bonds which are fully taxable – you can use the treasury data on corporate bonds below for averages.
Based on these calculations, which bond would you prefer and why? (You may just list pros and cons).
https://newyork.municipalbonds.com/bonds/yield_curve/
https://home.treasury.gov/data/treasury-coupon-issues-and-corporate-bond-yield-curve/corporate-bond-yield-curve
Question 4 20
Find a recent article in a reputable source that discusses corporate bankruptcies, or a bond downgrade. Please summarize what the article says and comment in view of what you have learned in class. – please copy the article or enclose a url.
Further instructions- The article should be 200-500 words long -you may cut a longer article. The choice matters as well as what you make of it. For example, an article that just describes what happened briefly is probably not a great choice (e.g. Apple bond was downgraded) but it can be good if you provide an in depth explanation or show why the presentation is or is not correct based on material covered in the class.
Question 5 25
a) Choose any mortgage with points from any site (please provide a url or copy the ad). What is the interest rate on that mortgage? What is the APR? Why are they different? Assume that you pre-pay the mortgage after one month, what is the APR you will have paid?
b) Assume that your mortgage forms a basis for a mortgage-backed security (any MBS is a pool of mortgages which are similar but hopefully not 100% correlated, but this question simplifies all of this).
It is carved into an interest only and a principal only tranche.
Show how the payments will be divided up for between the two tranches for the first three monthly payments.To make your life even simpler, assume that somehow only these three months paymets are securitized (possible, but unlikely). What will be the price of each tranche at issue assuming no pre-payment? Who wins and who loses if the mortgage pre-pays after one month, as in part a)? Please show a precise calculation.
All the best and good luck!
Appendix 1 Treasury yield curve
Date 1 Mo 2 Mo 3 Mo 4 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr
12/01/2022 4.04 4.24 4.33 4.52 4.65 4.66 4.25 3.98 3.68 3.62 3.53 3.85 3.64
12/02/2022 3.91 4.25 4.34 4.52 4.65 4.69 4.28 3.99 3.67 3.61 3.51 3.79 3.56
12/05/2022 3.93 4.25 4.36 4.56 4.73 4.77 4.41 4.13 3.80 3.72 3.60 3.84 3.62
12/06/2022 3.87 4.19 4.37 4.54 4.74 4.73 4.34 4.07 3.73 3.64 3.51 3.77 3.52
12/07/2022 3.79 4.10 4.29 4.53 4.72 4.67 4.26 3.97 3.62 3.54 3.42 3.66 3.42
12/08/2022 3.75 4.11 4.28 4.53 4.71 4.71 4.31 4.04 3.71 3.63 3.48 3.71 3.44
12/09/2022 3.81 4.13 4.31 4.54 4.72 4.72 4.33 4.07 3.75 3.69 3.57 3.82 3.56
12/12/2022 3.86 4.18 4.38 4.60 4.78 4.75 4.39 4.10 3.80 3.73 3.61 3.84 3.57
12/13/2022 3.89 4.16 4.35 4.58 4.70 4.64 4.22 3.96 3.66 3.60 3.51 3.74 3.53
12/14/2022 3.91 4.14 4.33 4.58 4.68 4.64 4.23 3.94 3.64 3.59 3.49 3.74 3.52
12/15/2022 3.95 4.24 4.34 4.56 4.70 4.65 4.23 3.96 3.62 3.56 3.44 3.69 3.48
12/16/2022 3.94 4.22 4.31 4.54 4.68 4.61 4.17 3.91 3.61 3.58 3.48 3.73 3.53
12/19/2022 3.95 4.24 4.37 4.57 4.71 4.64 4.25 3.99 3.70 3.67 3.57 3.82 3.62
12/20/2022 3.89 4.23 4.35 4.55 4.70 4.64 4.25 4.03 3.79 3.78 3.69 3.94 3.74
12/21/2022 3.90 4.23 4.33 4.57 4.67 4.60 4.21 4.00 3.78 3.77 3.68 3.93 3.74
12/22/2022 3.80 4.20 4.35 4.57 4.66 4.64 4.24 4.02 3.79 3.77 3.67 3.91 3.73
12/23/2022 3.80 4.20 4.34 4.59 4.67 4.66 4.31 4.09 3.86 3.83 3.75 3.99 3.82
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