A newly issued bond has a maturity of 2 years
Subject: Business / Finance
Question
A newly issued bond has a maturity of 2 years and pays semiannual coupons at annual rate of 7%. The par value of the bond is $1,000 and it sells at par.
a. What are the convexity and the duration of the bond?
b. Find the actual price of the bond assuming that its yield to maturity immediately increases from 7% to 8% (with maturity still 2 years)
c. What price would be predicted by the duration rule (the formula for the price change in terms of duration)? What is percentage error of that rule?
d. What price would be predicted by the duration-convexity rule (the formula for the price change in terms of duration and convexity)? What is percentage error of that rule?
A stock is currently trading at $50. Paul Tripp, CFA wants to value one-year index option using the single-period binomial model. The stock will either increase in value by 20% with probability of 30% or fall in value by 20% with probability of 70%. The annual risk-free interest rate is 2%. No dividends are paid on any of the underlying securities in the index.
a. Calculate the value of a European call option on the index with an exercise price of $50 by using one–period binomial model
b. Suppose that the market price of the call option considered in question a is $11. Do you have an arbitrage opportunity in this market? If yes, then find an arbitrage strategy (that is find your positions in an underlying stock, T-bills and call option)
