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INV2601 ASSIGNMENT 2 2021: GUARANTEED DISTINCTION
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INV2601 ASSIGNMENT 2 2021, Question 1
Answer: Reinvestment risk
Explanation
Lack of coupon payments on a zero coupon bond eliminates reinvestment risk.
Reinvestment risk is a type of risk that a bondholder is exposed to when they receive cash
inflows of which coupon payments are one.
They might have to reinvest those funds at a relatively low yield if interest rates have gone
down and thereby being exposed to reinvestment risk.
Question 2
Answer: 9.95%
Workings
To calculate the YTC:
On the financial calculator:
FV = 1 413.96
PV = -1 547. 68
PMT = 80 (0.16 x 1000 = 160/2)
N = 12 x 2
Comp I/Y? = 4.974219865 x 2 = 9.95%
NB: Remember to capture the current price (PV) as a negative since this represent the money
you would have to fork out if you are to hold this security.
Question 3
Answer = 18.71%
Workings
(1+𝑆3)3
1 year Forward rate 2years from now = ((1+𝑆2)2 ) – 1
(1+0.118)3
Forward rate = ((1+0.085)2) – 1 = 0.187041586 = 18.70%
Question 4
Answer = Segmented market theory
Explanation
It is the market segmented theory which postulates that the yield in one segment or class of
securities has no impact whatsoever on the other class. Thus yield on short term securities is
solely determined by supply and demand of short term securities whilst the yield on long term
securities is determined by supply and demand of long term securities.
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