E4711 Prof.
Dastidar Assignment #2
Hand in by a group of max two people. Late hand-in will NOT be accepted. Thanks for your
understanding.
Question 1
In spring of 2021, France issued a 50-year bond which was priced at par to yield 0.5930%. Issuing
very long-dated is quite the rage; England and other countries also do this.
1. Why would people want to buy such long dated claims?
2. How “long-dated” are these bonds in reality (i.e., what is the duration)? What is the
DV01 and Macaulay duration of this bond? As in class, assume there are semi-annual
coupons. Please describe how you obtained the number. If you’d like, include some
representative (not all) cells from your excel spreadsheet (cut and paste) so that we know
how you calculated this number.
3. Assume the yield increases to 2%. What is the loss from issue price? What is the
Macaulay duration and DV01 at this new yield?
Question 2: Forward Rates
Suppose the spot rate curve out to 5 years is given by
Time to Expiration (Years) .5 1 1.5 2 2.5 3 3.5 4 4.5 5
Spot Rate 4.5 4.25 4 4.25 4.5 4 3.5 3.25 3.0 2.75
Compute the corresponding 6-month forward rates for each period.
Question 3: Forward and Spot Rates
Given the entire spot curve (all the ri’s) and using the arbitrage arguments developed in class,
derive the formulas for the following forward rates.
1. The in 2.5-year for 6 months forward rate: 2.5f.5
2. The in 1-year for 5 years forward rate: 1f5
Hint: as in class, take two investment strategies, both starting with $1. Show that there are
two risk-less strategies, one with just a spot rate (zero coupon investment) and one with a
spot and forward investment.
E4711 Prof. Dastidar Assignment #2
Next, consider the following spot and forward rate information.
r.5 1.25 .5f5 3.75
.5f.5 1.5 .5f5.5 4
.5f1 1.75 .5f6 4.25
.5f1.5 2.00 .5f6.5 4.5
.5f2 2.25 .5f7 4.75
.5f2.5 2.5 .5f7.5 5
.5f3 2.75 .5f8 5.25
.5f3.5 3 .5f8.5 5.5
.5f4 3.25 .5f9 5.75
.5f4.5 3.5 .5f9.5 6
3. Plot the 6-month forward curve.
4. Note that all the forwards given begin in 6-months. Find the formula that gives you the
spot rates as a function of the forward rates. (Hint: think about the derivation of the
formula for forwards). 1
5. Solve for the corresponding spot rates and discount factors defined as .
(1+𝑟𝑛/2)2𝑛
6. Plot the zero coupon term structure (spot curve) along with the forward curve. Is it higher
or lower? Is this a general property?
Question 4: Forward Rate Arbitrage
Suppose you know first two spot rates: r0.5 = 6.0% and r1=5.5%. Assume these spot rates are
correct. You call your broker at Gold In Sacks, a prominent investment bank, and she is quoting
an in 6-months for 6 months forward rate of 0.5f0.5 = 5.75%. You are sure that this is an incorrect
quote.
a) Identify an arbitrage opportunity.
b) Construct an arbitrage trade, that is, show that by trading in the available instruments you
can make a riskless profit.
Question 5: Forwards and Swap
Assume you looked up prices of five T-bonds on Bloomberg:
Bond Maturity Coupon Price
1 6 months 0% 98.692
2 1.5 years 4% 101.461
3 1.5 years 1% 97.089
E4711 Prof. Dastidar Assignment #2
4 2.5 years 3% 99.469
5 3 years 2% 96.224
6 3 years 5% 104.749
1. Construct the term structure by bootstrapping the bond prices.
2. Derive a general forward rate formula for nfm.
3. Compute all possible forward rates. Explain in every detail how you computed two of
them.
4. Compute the 2.5-year swap rate. Explain your steps
