 # Two Qs for Fixed income

1. With respect to Liquidity Preference Theory, is the term struture of interest rates most likely related to: expectations about future rates, or interest rate risk. 2. A tax-exempt 3-year municipal bond at a yield of 3.86%, which is 100 BP less than a 3-year option-free U.S. Treasury. If a investor’s marginal tax rate is 32%, then the yield rato is close to? 3. Calculate porfolio duration: Bond A: Price: 102, Par Amouint owned \$7 million, Duration 1.89 Bond B: Price: 94.356, Par Amount owned \$5 million, Duration 7.7 Bond C: Price 88.688, Par Amount owned \$3 million, Duration 11.55 My opinion: 1. both of them. Since Liquidity Preference Theory covers pure expectation theory. Additionally, it takes the maturity (more or less, the interest rate risk) into account. 2. 3.86/4.86 = 0.79. 3. The key point is the weight. I think with respect to bond A the weight is (102*7)/(102*7+94.356*5+88.688*3). B and C likewise. Am I right?

That’s “Three Q’s”.

1. agreed but I’d go with interest rate risk. 2) The higher yield should go on top for the yield ratio? 3) No clue…

portfolio duration is just value weighted duration. 7/15 * 1.89 + 5/15 *7.7 + 3/15 * 11.55

can you post the answers? Thanks.

for 3 to get the weights i would do like this 1.02 * 7,000,000 / ( 1.02*7,000,000 + 0.94356 * 5,000,000 + 0.88688 * 3,000,000)

1. Both. The theory states that forward rates should reflect interest rate expectations and a liquidity premium that is positively related to maturity. 2) Ratio is 3.86/(.68*4.86)=1.168 3) 5.75867

this guy keeps posting q’s then dissapears with no answers!!!

6 posts only…

sekyzhuo - we are waiting for the answers…

I don’t think you use the taxable equivalent yield for yield ratio do you? Unless it asks?

Hi there, sorry for late. The answers recommended are as follows. 1. Neither. 2.1.26 ( I think SConnery might be right!) Thanks. 3. 7/15 * 1.89 + 5/15 *7.7 + 3/15 * 11.55 (as ryanwtyler said) Now, I still don’t think 1 or 3 is right. Hopefully, they may not confuse you guys.

I don’t think 3 is right. We have similar example in comprehensive problem section in shweser and he cacluates the weight based on market values not the par value which makes sense.

sorry you do have to multiply the par amount by price to get the weights

can someone please explain me to the liquidity preference theory? is there a page in the text book i can refer to? also are there any other theories we need to know? thank you.