Arbitrage in the Government Bond Market Case study Coursework

Essays on Arbitrage in the Government Bond Market Case study Coursework Full of 18 March Case Study: Arbitrage in the Government Bond Market Part A. Creation of Synthetic BondsThe cash flows of the callable bond which is valued at $4.2 billion in shown in Table 1 in the Appendix. The information in the table indicates that after the initial investment of $4.2 billion, interest payments of 4.125 which equates to $173.25 million is payable semi-annually. The net cash flow which is the interest over the five year period equates to a total of $1,732.5 million. The present value of these amounts is shown in the last row which indicates the present value cash flow (PVFCF). In order to capitalize on the mispricing in the bond market Ms Thompson discussed two options. One option involves creating a synthetic bond with the $4.2 million callable bond. This bond would pay the same interest as the May’00-05’callable bond. The amount of 12% May05’ bonds required to match the coupon payments of the callable bond are as follows: X Ãâ€" 12% Ãâ€" 100 = 8.25% Ãâ€" 100 X Ãâ€" 12 = 8.25 Dividing both sides by 12 yields: X = 8.25/12 Therefore, X= 0.6875 The fraction of 12% May 05’ treasury bonds required is 0.6875. Therefore, the fraction of treasury STRIP required to pay the principal amount at maturity is 0.3125 (1 – 0.6875). The ask price and bid price of the May 05’ synthetic bond is therefore calculated as follows: Ask price = 0.6875 Ãâ€" 129.901 + 0.3125 Ãâ€" 30.312 = 98.78 Bid price = 0.6875 Ãâ€" 129.7188 + 0.3125 Ãâ€" 29.91 = 98.53 The alternative option would involve the 8.875% May 00’. A similar calculation as that used in the previous option. The following calculations provides information on the fraction of 8.875% May 00’ noncallable treasury bonds and May 00’ Treasury STRIPS required to match the 8.25% May 05’ interest payments and principal payment at maturity. X Ãâ€" 8.875% Ãâ€" 100 = 8.25% Ãâ€" 100 X Ãâ€" 8.785 = 8.25 Dividing both sides by 8.875 yields: X = 8.25/8.875 Therefore, X= 0.9296 The fraction of 8.875% May 00’ treasury bonds required is 0.9296. Therefore, the fraction of treasury STRIP required to pay the principal amount at maturity is 0.0704 (1 – 0.9296). The ask price and bid price of the May 00’ synthetic bond is therefore calculated as follows: Ask price = 0.9296 Ãâ€" 104.5 + 0.0704 Ãâ€" 46.656 = 100.43 Bid price = 0.9296 Ãâ€" 104.375 + 0.0704 Ãâ€" 46.25 = 100.28 Part 2 – Case for Mispriced Callable Bonds The May ’00 – ’05 callable Treasury bond is overpriced. The information in Table 2 in the Appendix indicates this. Investors can sell the May ’00 – ’05 callable Treasury bond at the bid price of $101.125 and buy the cheaper priced synthetic bond at the bid ask price of 98.78. The profit on the transaction would be worth 2.2345 per share or $98.49 million. If the both the callable and the synthetic bond had the same price the investor should prefer to buy the synthetic bond. The reason is that when the interest rate on a callable bond falls the government is likely to call the bond since they will be able to refinance it at a lower rate of interest. The May ’05 bond should therefore be worth more because it is a noncallable Treasury bond and therefore provides the government with an option. The May ’00 synthetic bond is also worth more than the May’00 – ’05 callable bond because when the level of interest rate rise the government will not call the callable bond since it is at a lower rate. Part 3 – The Case of a Bond Trader Who Does Not Currently Own the Callable Bond Part 4 – Varying Scenarios Part 5 Fall in the Price of Callable Bond by 150bps in One Year If the price of the callable bond falls by 150 basis points below that of the synthetic bond with corresponding maturity then the (asked) yield-to-maturity of the synthetic bond which was constructed using the May ’05 non callable bond and the May ’05 STRIP would be as follows: Yield–to-Maturity (YTM) is the rate of return on the bond if it is held until it matures. It is found using the equation for value of the bond Vb, in which rd is the return. Vb = 98.78 = (8.875/2)/(1+ rd/2)1 + (8.875/2)/(1+ rd/2)2 + (8.875/2)/(1+ rd/2)3+ (8.875/2)/(1+ rd/2)4 + (8.875/2)/(1+ rd/2)5 + (8.875/2)/(1+ rd/2)6 + (8.875/2)/(1+ rd/2)7+(8.875/2)/(1+ rd/2)8 + (8.875/2)/(1+ rd/2)9 + (8.875/2)/(1+ rd/2)10 YTM = rd= 4.595% YTM (ask) synthetic May’05 is 4.595% The YTM (bid) on the synthetic May ’05 bond is Vb = 98.53 = (8.875/2)/(1+ rd/2)1 + (8.875/2)/(1+ rd/2)2 + (8.875/2)/(1+ rd/2)3+ (8.875/2)/(1+ rd/2)4 + (8.875/2)/(1+ rd/2)5 + (8.875/2)/(1+ rd/2)6 + (8.875/2)/(1+ rd/2)7+(8.875/2)/(1+ rd/2)8 + (8.875/2)/(1+ rd/2)9 + (8.875/2)/(1+ rd/2)10 YTM = rd = 4.627% If the callable bond one year from now is 150bps below that of the synthetic bond with corresponding maturity the expected asked price of the synthetic bond and the bid price of the callable bond one year from now is as follows: Asked price of synthetic bond one year from now: Vb = 98.78 = (8.875/2)/(1+ rd/2)1 + (8.875/2)/(1+ rd/2)2 YTM = rd= 5.097% Bid price of the callable bond one year from now using the bond valuation formula is: Vb = 99.61 = (8.25/2)/(1+ rd/2)1 + (8.25/2)/(1+ rd/2)2 YTM = rd= 4.338% A higher the rate means that the returns are better. Even as the price of the callable bond falls below par value the yield is less than that of the synthetic May ’05 synthetic bond because it is still overpriced. Use of $10 million Loan Assuming no securities are owned and $10 million is borrowed on the repo market to perform the transaction in order to exploit the arbitrage opportunity and assuming other securities can be posted as collateral. Since I own no securities then I would borrow some and collateralize it using the $10 million loan. I would then sell the security in a short sale. I would therefore have to pay the interest of 4.125 semi-annually until I am ready to return the bond. When that time comes I would enter the market and purchase the bond if it is not overpriced or I would enter into a similar borrowing arrangement with another bond holder. Buy-and-Hold Strategy If I use a buy-and-hold strategy for one year, my arbitrage profit would be calculated as follows: Repurchase Arrangements Description    $mn Interest Repo Market Loan 10 (527000) Borrow 8.25 May 00 - 05 10 (825000) Sell short 8.25 May 00 -05 Callable bond 10.04 828300 Net Profit/loss       (523700) Figure 1 Much of the information in Figure 1 would result in a profit if I had investments of my own. The difference between long-term borrowing and short sales indicate that borrowing bonds and selling them short has major benefits but the cost of the funds used to so may outweigh the benefits which is the case in Figure 1, the result been a loss of $523,700. Attribution Analysis Most of the profit under section (a) can be attributed to directional value trading as it is assumed that the callable bonds are overvalued when compared with the synthetic bonds. This mispricing is expected to be corrected in the future. Works cited Edleson, M.E and Tufano, P. Arbitrage in the Government Bond Market? Boston: Harvard Business School. 1995. Print. Appendix Cash Flow Table for 8.25% May 00- 05 Callable bond Date/ Period 0 1 2 3 4 5 6 7 8 9 10 Net Cash Flow Cash flow (4200) 173.25 173.25 173.25 173.25 173.25 173.25 173.25 173.25 173.25 4373.25 1732.5 PV 1 1.0413 1.0842 1.1289 1.17549 1.22398 1.2745 1.327 1.3818 1.4388 1.49813    PVFCF (4200) 166 160 153 147 142 136 131 125 120 2919 0 Table 1 Calculation Showing that Callable May 00 - 05 Bonds are Mispriced Description    Millions Price Value ($mn) Callable Bonds    42 101.125 4247.25 Synthetic Bonds:             May 05 TB    42 98.78 4148.76                Profit       2.345 98.49 Table 2

Examplification essay sample Free Essays

In fact, most students in US often take the online courses for each semester. The classes can be taken where It Is convenient for students: at home, office, on a military base or the other places. Students have the opportunity on choosing from various schools and courses which might be taught in another city or states. We will write a custom essay sample on Examplification essay sample or any similar topic only for you Order Now Classrooms are available 24 hours a day, seven days a week so students can take the announcements, discuss a topic, and review their homework at any time they want. However, students who first attend in online courses can get the trouble because of differences between online courses and on campus courses. There are some tips for students to achieve success in online college courses. First, students have to have some basic skills about computing. It Is the most Important material which Is required for online courses. Every students should have a computer if not they can study at library or internet coffee restaurant but they must know about computer acknowledge In fact, students in online course work through the computer all the time. For example, students have to log in to the web page of heir school to see the activities of the course. They have to email their professor to communicate, ask questions, and chat with follow classmates. In addition, some courses may require students to install software needed to study and download file which professors provide. Students can contact to students service to find the answers about the courses resource, or technical support to resolve problem Is related to learning system. Students need these skills to study, to communicate and to resolve the problem could have during the courses. In online course self-works plays a main role in it. Students have to manage time, make It suitable for their study schedule and work schedule. There are no one will remind students about homework and tests. students should suck to the syllabus, read it and use it as a tool to remind because it includes the calendar about the assignments, the test. Students need to keep track the due of them in the courses. Students also need to set up a place for study online which needs concentration, quiet so they can focus on their work without distraction. Students can choose to study in library where all the material they need as computers, books, have and there s quiet. Students can ask the librarians about technical issues and it will be resolved Immediately. Studying at home also Is a good idea. Students control all their rules at home that make them easier to set time for study when their family go out, or study at midnight then students are set free out of interferences. They will feel more comfortable to focus on studying. Next, students should study actively, they cannot wait for help when they got a trouble, they need ask for help as soon as possible. When they get a different subject or the professors explain something Is not bviously, students could be confused, lost. Students need to type, email, and find the answers they need. This is not a time to be scare or embarrassing to show their opinion. In addition, practice is a key for student to succeed, the more they practice the better result they gain. Most think online course are easier than normal courses. It Is big difference. Times for students to study are reduced and the courses go 1 OF2 where students face to face instruction. They have to practice more from the internet resource or from the text book by themselves to reinforce their knowledge and study well in the online courses. Finally, students should be optimistic. During the course, getting a low grade is one thing they might not prevent. Professor could consider them to taking a full course because their grade, their trouble but before the end students don not give up. Sticking with purposes, goals were set when taking the course. They need to learn from the errors to get better. If students made a mistake, do not ignore or avoid it, they should try to fix it by themselves, ask somebody like classmates, professors and if they cannot help, try to do a research in the internet, try the best they can to find the answers. Taking time and thinking positive to practice and improve will help students are successful. Online courses open more the opportunity for students to attend in school. They can succeed their goals like to improve their skills, reinforce knowledge, and get a degree. Online courses provide advantages for students such as flexible in doing assignment, no sitting in class, balance a Job and class. However, it also challenges students who first attend in the online course. Basic computing skills, create a schedule time, and study optimistically will help students improve the chances to achieve success in online college courses. How to cite Examplification essay sample, Essays

The Monetary Policy of Federal Reserve to Fight against Unemployment R

Question: Describe about the Monetary Policy of Federal Reserve to Fight against Unemployment Rate? Answer: Summary:- This assignment is based on the Houston Business Journal written by Kent Hoover on 17th Jun, 2015 (as given in the appendix portion). The title of the news journal is Fed wants to see more jobs before it raises interest rates. This newspaper journal is indicating the monetary policy of Federal Reserve regarding interest rate and employment. This relationship between interest rate and employment also represents the relationship between inflation and unemployment rate, as there is a deep relationship between interest rate and price-level. So, the following assignment has discussed about the current trend of inflation and unemployment rate of U.S. and its impact on the economy. It has also discussed the policy of Federal Reserve (the central bank of U.S.) regarding inflation and unemployment rate. Introduction:- U.S. is the most developed country in this world. But, the economy of U.S. was badly affected by the global financial crisis of 2000s. Due to this financial crisis many people lost their jobs which led to an increase in unemployment rate. Federal Reserve is trying to reduce this unemployment rate, by monitoring the interest rate policy (Beckworth 2012). Identifying the macroeconomic model:- According to the selected news paper journal, the Federal Reserve is monitoring the interest rate to increase more job rate. This monetary policy of Federal Reserve depends on the macroeconomic theory of Phillips curve. According to the Phillips curve, there is an inverse relationship between inflation and unemployment rate. That is higher the inflation rate, lower the unemployment rate (or higher the employment rate) and lower the inflation rate, higher the unemployment rate (or lower the employment rate). Again there is a strong relationship between inflation rate and interest rate. At the high inflation rate, government always tries to increase the interest rate to reduce the money supply or cash flow in the hand of the common people. But in this high rate of inflation, the employment level is also high, as per the norms of Phillips curve (Krugman 2015). The relationship between inflation and unemployment can be shown by using the Phillips curve diagram, as in follows: - From the above figure, it can be shown that, in case of short-run Phillips curve, if Inflation rate is I1, then unemployment rate is U1. Now, if the inflation rate increases from I1 to I2, then the unemployment rate fall from U1 to U2. This decline in unemployment rate indicates the increase in employment rate .Hence, there is a positive relationship between inflation rate and employment. Therefore, to increase the employment rate, existence of inflation in some extent is necessary for any country (Mankiw 2012). That is why the Federal Reserve wants to see more jobs before it raising the interest rate. U.S. has just overcome from the financial crisis and the present rate of inflation of U.S. is -0.2%. This is a very low inflation rate and the Federal Reserve desires high inflation rate than that which can help in increasing the employment rate. At this moment, if Federal Reserve increases the interest rate, then the amount of cash flow in the economy will decline which will lead to a fall in inflation rate farther. And, a fall in inflation rate will result a fall in employment rate, which is not desirable for development of the U.S. economy. The present scenario of U.S. economy in terms of inflation and unemployment rate:- Year Annual GDP growth rate (%) Inflation Rate (%) Unemployment Rate (%) Interest Rate (%) 2005 3.3 3.5 5 2.9 2006 2.2 2.0 4.5 4.7 2007 2.3 2.5 4.7 5.2 2008 0.8 1.1 6.8 3.1 2009 -3.3 -0.2 9.9 2.4 2010 3.1 1.1 9.8 2.0 2011 1.2 3.4 8.7 1.2 2012 2.7 1.8 7.8 1.4 2013 2.3 1.2 7.0 1.7 2014 2.7 1.3 5.8 1.7 2015 2.9 -0.2 5.5 1.7 Hence, from the above chart and diagram, it can be shown that in last decade i.e. from 2005-2015, there is a fluctuation in economic growth rate. From 2005 to 2009 there is a continuous fall in GDP growth rate from 3.3% to -3.3%. But from 2010, it started to recover and reached at 3.1%. But after 2010, it again declined at 1.2% at 2011. After 2011, it again started to increase and has finally achieved the growth rate of 2.9% (Tradingeconomics.com 2015). Now, concentrating on the data of inflation rate of U.S. over the period 2005-2015, it can be seen that with the fluctuation of annual GDP growth rate, the rate of inflation has always fluctuated over the period. With the decline in GDP growth rate during the period of financial crisis (2005-09), the inflation rate has also declined and in 2009, when the GDP growth rate was negative (-3.3%), the inflation rate faced by the country was also negative (-0.2%). With the increase in GDP growth rate from 2010, the inflation rate also started to increase. But, in the present year, it again fall to the level of -0.2%, though there is a rise in the GDP growth rate (2.9%) compare to the previous year (2.7%). From the above data and chart, it can also be seen that with the fall in inflation rate, there is a rise in unemployment rate in U.S. economy all over the period of last ten years, which is following the principle of Phillips curve. But in 2015, when the inflation rate is lowest i.e. -0.2%, the unemployment rate has also declined at 5.5% from 5.8%. This is an exceptional case, when lower inflation leads to lower unemployment rate. This situation has occurred just for the lack of job opportunities (Data.worldbank.org 2015). During this period, the rate of real interest rate has also fluctuated over the period. From 2005 to 2007, the real interest rate of U.S. economy was increased by Federal Reserve to control the inflation rate. In 2009, the inflation rate was much lower and as a result, the Federal Reserve started to decline the interest rate to achieve a minimum level of inflation as increase in inflation leads to increase in employment rate (Houston Business Journal 2015). At present, where inflation rate is negative, Federal Reserve has decided not to increase its inflation rate further. That is why the real interest rate in U.S. is remain same at the level 1.7% during the past three years (i.e. from 2013-15). Reasons behind recession and decline in employment rate in U.S. GDP:- Though there was a sign of economic slowdown in 2006, the recessionary phase in U.S. started to begin from the end of 2007 and became clearly noticeable in 2008 (Cushman 2015). This recession caused a massive cut-off in the total employment level of U.S. The main reasons, behind this great recession are:- Shadow banking system: - In U.S., there was existence of Shadow banking system. This Shadow banking system includes the investment bank and other financial entities which are non-depositary. Though it was not subject to the same regulatory safeguards as the depository system, it had grown to rival the depository system. Housing Bubble:- Housing bubble was the most important characteristics of U.S. economy. There was a fall in private residential investment in housing construction nearly four percent, when this housing bubble burst. This led to a decline in GDP rate and consumption level and U.S. government was not willing to compensate the shortfall of private sector (Koutentakis 2014). Household debt:- In U.S., once the housing prices began falling in 2006, there were a record levels of household debt accumulated in the decades preceding the crisis which resulted a balance sheet recession. As a result, the consumers began paying down debt, which reduced their consumption and slowed down the economic growth rate during the period of 2006-2008 (Martin, Sunley and Tyler 2015). Government policy and financial turmoil:- The economic policies taken by the U.S. government towards the housing market was also a cause behind the recession faced by U.S. economy. There was also financial turmoil which led to a rise in money demand and a fall in commodity demand (Gosling and Eisner 2015). Conclusion and recommendation:- Hence, from the above discussion it can be said that to increase the employment rate, stabilization policy of Federal Reserve regarding the interest rate is not enough. Inflation may not increase even after taking that stabilization policy as seen in the year 2015. For declining the unemployment rate in U.S. economy, it is very essential for U.S. government to adopt some relevant policies for increasing the job opportunities in U.S. labor market. Seven types of policies may be discussed in this regard, such as, providing compensation to the consumers, providing unemployment insurance to the laborers, simplifying the tax for the small business, proving health-care facilities, implementing the regulatory reform etc. Appendix:- Houston Business Journal https://www.bizjournals.com/houston/news/news-wire/2015/06/17/fed-wants-to-see-more-jobs-before-it-raises.html Fed wants to see more jobs before it raises interest rates (Video) Jun 17, 2015, 1:44pm CDT Kent HooverAs expected, the Federal Reserve decided against raising its federal funds rate this month from the near-zero levels its been since the financial crisis.In its statement, the Fed said it wont begin raising interest rates until it has seen further improvement in the labour market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. The Fed, however, sounded fairly confident in the economys progress since a dead-in-the-water first quarter. Since then economic activity has been expanding moderately, it noted. More jobs are being added, household spending has grown moderately, and the housing sector has shown some improvement, it noted. However, business fixed investment and net exports stayed soft, the Fed said. Inflation continued to run below the committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Going forward, it expects the economy to grow at a moderate pace, with the labour market continuing to improve. So now the question is whether the Fed will start to raise interest rates in September, or wait until December. Fifteen out of 17 Fed members expect it will start to raise interest rates this year; the other two said that should wait until next year. References Beckworth, David M. 2012.Boom And Bust Banking. Chicago: Independent Institute. Cushman, Thomas. 2015. 'The Moral Economy Of The Great Recession'.Soc52 (1): 9-18. doi:10.1007/s12115-014-9852-4. Data.worldbank.org,. 2015. 'Data | The World Bank'. https://data.worldbank.org/. Gosling, James J, and Marc Allen Eisner. 2015.Economics, Politics, And American Public Policy. Hoboken: Taylor and Francis. Houston Business Journal,. 2015. 'Federal Reserve Keeps Interest Rates Unchanged; Waiting For Additional Jobs, Higher Inflation Before Increasing Federal Funds Rate (Video) - Houston Business Journal'. https://www.bizjournals.com/houston/news/news-wire/2015/06/17/fed-wants-to-see-more-jobs-before-it-raises.html. Koutentakis, Franciscos. 2014. 'Gender Unemployment Dynamics: Evidence From Ten Advanced Economies'.LABOUR29 (1): 15-31. doi:10.1111/labr.12037. Krugman, Paul. 2015.Macroeconomics. [Place of publication not identified]: Worth Pub. Mankiw, N. Gregory. 2012.Macroeconomics. New York: Worth. Martin, R., P. Sunley, and P. Tyler. 2015. 'Local Growth Evolutions: Recession, Resilience And Recovery'.Cambridge Journal Of Regions, Economy And Society8 (2): 141-148. doi:10.1093/cjres/rsv012. Tradingeconomics.com,. 2015. 'TRADING ECONOMICS | 300.000 INDICATORS FROM 196 COUNTRIES'. https://www.tradingeconomics.com.