Sep 18, 2017

QUESTION 1EVALUATE THE FOLLOWING STATEMENTS:(A) IF THE FUTURE SPOT RATES ARE EXPECTED TO BE LOWER…

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Question 1Evaluate the following statements:(a) If the future spot rates are expected to be lower than the current forward rates for the same maturities, bonds are most likely to be overvalued, according to the expectations hypothesis. (5 marks)(b) Z-spread is the spread over the Treasury spot curve that a bond would trade at if it had no embedded option. (5 marks)(c) If the binomial tree is correctly calibrated, it should give the same value for an optionfree bond as using the spot curve (par curve) used to calibrate the tree. (5 marks)(d) If a firm’s credit rating remains stable over time, the correlation its default probability over the business cycle would be reduced. (5 marks)(e) Zero coupon bonds (ZCB) have duration equals to its maturity. Hence, ZCB’s price sensitivity to interest rate change is the same regardless of the interest rates level. (5 marks)


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