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 Subject: Finance Category: Business and Money > Finance Asked by: sophisticated1-ga List Price: \$20.00 Posted: 12 Oct 2006 19:27 PDT Expires: 11 Nov 2006 18:27 PST Question ID: 773073
 ```I need "EITHER" a Discussion "OR" mathamatical calculations for this particular question. If I entered into a forward contract to buy a 10 year, zero coupon bond that will be issdued in one year. The face value of the bond is \$1000, and the 1 year and 11 year spot interest rates are 4% per annum and 9%, respectiviely. Both of these interest rates are expressed as effective annual yields (EAYs). (Calculations would be to answer A and B) A. What is the forward price of your contract? B. Suppose both the spot rates unexpectively shift downward by 1%, what would be the price of a forward contract identical to mine? -OR- (A discussion would be to answer the following questions.) 1.What financial concept or principle is the problem inquiring about? 2. With the context of the problem in mind, what are some business decisions that a manager would be able to make with solving this problem? 3. Is there any additional information that would enhance the decision making process within this questions? 4. Without showing any math calculations, in writing how would this problem be solved?```
 ```Hello! I will give you the mathematical calculations you need in order to solve this problem. Part A In order to get the price of the contract, we should first find the 1 year forward 10-yr interest rate. That is, we need to find what is the expected spot 10-yr rate one year from today. This value can be found using arbitrage arguments. The 11-yr rate today is 9%. Therefore, an 11-year investment of \$1 today would return 1.09^11 = 2.5804... in 11 years. This investment is equivalent to investing \$1 today for 1 year (at the spot 1-yr rate) and then, at the end of the 1st year, reinvest it for 10 years, at whatever spot rate that holds at that time. That rate is the 1 year forward 10-yr rate, and should be such that the returns from both investments are equal. The return from this investment would be: 1.04*(1+r)^10 Therefore, the forward 10-yr rate comes from this equation 1.09^11 = 1.04*(1+r)^10 (1+r )^10 = (1.09^11)/1.04 r = ((1.09^11)/1.04)^(1/10) - 1 = 0.09513... So the 1 year forward 10-yr rate is approximately 9.51%. So the present value of an investment that returns \$1,000 in 10 years, discounted at this rate, would be: 1000/(1.09513)^10 = 403.03 Therefore, in one year you would pay \$403.03 for the 10-yr bond. That's exactly the forward price of the contract. b. We must recalculate the 1 year forward 10-yr rate. Using the same reasoning as before, we find that it will be: r = ((1.08^11)/1.03)^(1/10) - 1 = 0.08513... The forward rate will thus fall to 8.51%. So the forward price of the contract will be: 1000/(1.08513)^10 = \$441.75 As you can see, since the forward rate falls as a result of the decrease in the spot rates, this will cause the price of the bond to increase. You can find a summary on bond pricing methods in the PowerPoint presentation at the following link: A Primer on Bond Pricing http://www.cob.ohio-state.edu/~sanders/bond_pricing.ppt Google search terms bond foward pricing ://www.google.com.ar/search?hl=es&q=bond+forward+pricing&meta= I hope this helps! If you have any doubt regarding my answer, please don't hesitate to request clarification before rating it. Otherwise, I await your rating and final comments. Best wishes! elmarto```
 sophisticated1-ga rated this answer: ```Thanks alot for everything, the info for research on this problem is excellent just as the mathmatical solution!!```