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Question Two You are an Investment Analyst at MSC INC. On 06/08/2021 a new client has tasked you with investing $150m in the following two US corporate bonds holding $100m in AM and the remaining $50m in BT: AM Bond BT Bond Coupon Par T (years) 15% $1,000 3 15% Ba1 8% $1,000 3 6% Aa1 Moody's Rating Your client instructs you that they wish to benefit from changes in the yield to maturity and insists that you actively manage the portfolio moving funds on a daily basis. On the 07/08/2021 the Federal Reserve announces an imminent increase in the Federal Funds rate by 2%. Your analysis indicates that the yield to maturities on AM and BT bonds will both rise by 100% of the announced increase in the Federal Funds rate. Required: a) Compute the Price, Duration, Modified Duration and Convexity factor of AM and BT bonds using the information in the table above. [30 marks) b) Calculate the Duration and Modified Duration of your bond portfolio. If you expect a large fall in interest rates, how would you change the amount invested in each bond and why? [20 marks] c) Produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021 using only modified Duration. [20 marks) d) Accounting for convexity, produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021. Explain the importance of accounting for convexity in terms of the estimation error in your expected portfolio value at the end of trading 07/08/2021. Question Two You are an Investment Analyst at MSC INC. On 06/08/2021 a new client has tasked you with investing $150m in the following two US corporate bonds holding $100m in AM and the remaining $50m in BT: AM Bond BT Bond Coupon Par T (years) 15% $1,000 3 15% Ba1 8% $1,000 3 6% Aa1 Moody's Rating Your client instructs you that they wish to benefit from changes in the yield to maturity and insists that you actively manage the portfolio moving funds on a daily basis. On the 07/08/2021 the Federal Reserve announces an imminent increase in the Federal Funds rate by 2%. Your analysis indicates that the yield to maturities on AM and BT bonds will both rise by 100% of the announced increase in the Federal Funds rate. Required: a) Compute the Price, Duration, Modified Duration and Convexity factor of AM and BT bonds using the information in the table above. [30 marks) b) Calculate the Duration and Modified Duration of your bond portfolio. If you expect a large fall in interest rates, how would you change the amount invested in each bond and why? [20 marks] c) Produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021 using only modified Duration. [20 marks) d) Accounting for convexity, produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021. Explain the importance of accounting for convexity in terms of the estimation error in your expected portfolio value at the end of trading 07/08/2021

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