COURSE 6 MORNING SESSION SECTION A-WRITTEN ANSWER Course 6: Spring 2003 - 1 - GO ON TO NEXT PAGE **BEGINNING OF EXAMINATION** 1. (6 points) You are given the following with respect to corporate bonds: Rating Spread Over Treasuries (basis points) AAA 20 AA 30 A 40 The one-year rating transition matrix is as follows: Rating at End of Year Rating at Beginning of Year AAA AA A AAA 0.8 0.1 0.1 AA 0.1 0.7 0.2 A 0.0 0.1 0.9 (a) Describe the top down value-added strategies for active bond management. (b) Describe the corporate bond sector 0selection strategies. (c) Calculate the expected two-year horizon spread over Treasuries for a AAA-rated bond. Show all work. Course 6: Spring 2003 - 2 - GO ON TO NEXT PAGE 2. (5 points) You are given the following: Probability One Year Return Stock X 0.60 0.20 0.20 10% 5% -10% Stock Y 0.75 0.25 20% -20% •...risk-free rate is 4% •...the investor has a one-year horizon •...the investor is indifferent between investing in Stock Y and earning the risk-free rate Determine whether or not the investor would purchase Stock X. Show all work. Course 6: Spring 2003 - 3 - GO ON TO NEXT PAGE 3. (5 points) You are given the following: •...margin requirement on short sales: 50% •...maintenance margin: 30% •...an investor’s account with a broker currently holds: •...value of T-bills: 10,000 •...number of shares of XYZ stock: 500 •...stock prices: Date ABC Stock Price XYZ Stock Price June 2, 2003 103 75 June 3, 2003 102 76 June 4, 2003 99 77 June 5, 2003 100 75 June 6, 2003 101 80 June 9, 2003 105 72 June 10, 2003 115 65 The investor tells the broker to short 1,000 shares of the ABC stock on June 3, 2003. The broker executes the order on the first day allowed. Shares are traded once per day. (a) Calculate the additional cash (if any) necessary to satisfy the margin requirement. (b) Calculate the amount of the margin calls (if any) between June 3, 2003 and June 10, 2003. Show all work. Course 6: Spring 2003 - 4 - GO ON TO NEXT PAGE 4. (9 points) You are given the following with respect to an Extended Vasicek Trinomial Lattice Model: •...s ..0.02 •....t ..1 year •...Rb1g..0.08 •...Rb2g ..0.09 •...Rb3g ..0.10 •...a ..0.4 (a) Describe the key characteristics of this model. (b) Calculate the value of qb0g using the Hull and White approximation. (c) Calculate the value of p2 a0,0f. (d) Calculate the value of a one-year cap with a notional amount of 100 and a strike interest rate of 9.5%. Show all work. Course 6: Spring 2003 - 5 - GO ON TO NEXT PAGE