# 2 Q's

1. An investor has a 1 year, semiannual, 10% coupon bond which is price at \$1025. If the 6mo spot rate on the bond equv. basis is 8%, the 1 year theoretical spot rate as BEY is: 6.4 7.3 8.0 8.2 Which of the following would be least likely to proved an effective hedge for an investor with a portfoilio primarily in fixed-coupon bonds? Sell bond futures Buy comodity linked equities Buy commodity options Buy interest rate puts.
1. Strapping the bond: 1,025 = 50/1.04 + 1,50/(1+x)^2, solve for x and multiply it with 2, x = 3.67, on BEY would be 2*3.67~7.34 say 7.3, B 2. The greatest risk (for a portfolio of bonds) is for interest rates to increase, which will decrease the value of your portfolio. To hedge, you need to make money when rates are going up. Of the answers provided, D (buying put rates) is making money when rates go down, not up. You need the least likely answer, must be D.

Thanks.

Could you please explain solution for question number 1? Is there a specific formula for that? Thanks

The correct value of a bond is the present value of future cash flows, with each cash flow discounted at the corresponding spot rate. There’s a good explanation of why this is true in the cfai book