TMA Template FIN357e Fixed Income Securities Tutor-Marked Assignment July 2019 Presentation FIN357e Tutor-Marked Assignment SINGAPORE UNIVERSITY OF SOCIAL SCIENCES (SUSS) Page 2 of 5 TUTOR-MARKED...

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Answer To: TMA Template FIN357e Fixed Income Securities Tutor-Marked Assignment July 2019 Presentation FIN357e...

Guneet answered on Oct 12 2021
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FIXED INCOME SECURITIES
 
 
 

 
 

SU1: FIN357e
FIXED INCOME SECURITIES
Student Name:
Name of the Project:
Professor:
October 12, 2019
 
 
 
 
 
Question 1
(a)    Suppose that you are given the following information about two callable bonds of the same issue that can be called immediately:
You are told that both bonds have about the same maturity and the coupon rate of one bond
is 7% and the other is 13%. Suppose that the yield curve for this issuer is flat at 8%. Based on this information, evaluate which bond is the lower coupon bond and which is the higher coupon bond? Explain why. (7 marks)
Solution:
    
    ABC
    
    -0.50%
    
    0.50%
    bond price
    1000
    995
    
    1005
    
    Int. rate
    7%
    7.14%
    
    6.65%
    
    
    XYZ
    
    -0.50%
    
    0.50%
    bond price
    1000
    995
    
    1005
    
    Int. rate
    13%
    14.43%
    
    11.96%
    
The above tables clearly states the changes in price due to changes in its interest rates. The yield curve is flat at 8%. Bond ABC is a low coupon bond as the interest rate is lower than the yield curve. Bond XYZ is high coupon bond as the interest rate is more than the flat yield curve rate of 8%.  Therefore the bond which has a better coupon rate is XYZ as its coupon payments are higher than ABC and the flattened yield curve.
(b) Suppose that a 6% coupon corporate bond is immediately callable. Also suppose that if this issuer issues new bonds the coupon rate would be 12%. Why would the modified duration be a good approximation of the effective duration for the old bond? (6 marks)
If the 6% bond is immediately callable then the modified duration will be a good approximation of the effective duration for the old bond. It is because an embedded option bond behaves like an option free bond if there is no benefit to issuer. The increase in interest rate from 6% to 12% will not be an optimal option as it lead to a higher payment of interest. Therefore it will not benefit the bond issuer in any way to call the previous bond. So for this scenario modified duration will be a good approximation of the effective duration of the old callable bond. 
(c) A three-year old 10-year 9% semi-annual coupon bond is selling at $1,138.8245 today. If the yield increases by 75 basis points, how much of the price change is due to convexity of the bond? (Face Value = $1,000) (7 marks)
Solution: 
We will solve this problem using Macaulay Duration and Modified Duration as the bond is convex, where the price and interest rate move in the opposite direction. Below is the calculation explained:

As per above formula, The macaulay duration comes to 6.84.
Now we will calculate the modified duration using the above macaulay duration.
As per above formula, modified duration is 6.28%. This means if the interest rate increases by 75 basis points, the price of the bond will decrease by 6.28% due to convexity of bond. This means the price will decrease from $ 1138.8245 to $ 1067.33.
 
FIN357e Tutor-Marked Assignment SINGAPORE UNIVERSITY OF SOCIAL SCIENCES (SUSS) Page 3 of 5 
Question 2 
“Hyflux default signals more trouble ahead for Singapore bond market: S&P”. (Headline in Business Times article dated 9 April 2019)
Solution: 
(a) Based on your understanding of credit analysis, analyse the claim in the headline of the article. (10 marks) 
Solution:
Credit Analysis of companies has become an essential part of credit scoring agencies, rating agencies and for a company’s stakeholders to know the true position of business performance. Credit problems in a bond portfolio are the primary cause of non-payment of bond obligations for holders of fixed income securities. Thus, the analysis of credit risk is of primary importance to holders of such securities. The purpose of credit analysis is to generate profitable bond portfolios that do not expose bond holders to excessive amounts of risk. Corporate bonds are essentially loans to corporations. 
Traditional Credit Analysis: This includes detailed analysis and is a detailed process involving four C’s...
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