6.00. Show your calculations.
4 minutes (Answer 2-A on page 12)
B. Calculate the minimum change (in bps) in the yield for the Tauravia bond that would
eliminate its quarterly yield advantage relative to the Scorponia bond. Show your
calculations.
Note: Ignore the impact of currency movements.
4 minutes (Answer 2-B on page 13)
C. Determine whether the Tauravia bonds would have a higher expected return over the
coming year if the currency exposure is fully hedged or unhedged. Justify your
response. Show your calculations.
Note: Assume MacDougal’s spot exchange rate forecast is correct and there are no
changes in the yield curves.
4 minutes (Answer 2-C on page 14)
The current credit spread of the corporate bonds in MacDougal’s portfolio relative to
government bonds is 100 bps. MacDougal is concerned that the credit spread could widen due to
changes in overall market conditions. He investigates using either a credit spread forward or a
credit spread call option to hedge against the expected spread widening. The credit spread
forward’s contracted spread is 100 bps and the credit spread call option has a strike spread of
100 bps.
D. Select, for each of the following, the most appropriate hedging strategy (buy long or sell
short) that would address MacDougal’s concern using a credit spread:
i. forward contract.
ii. call option contract.
Determine whether each strategy has a negative, zero, or positive payoff to Ethereal if
the credit spread is 150 bps at expiration.
6 minutes (Answer 2-D on page 15)
Several years later, the corporate bonds in the portfolio are valued at SCF 200,000,000 and they
are not leveraged. MacDougal forecasts that interest rates will decrease, and he would like to
increase the duration of this portion of the portfolio. MacDougal decides to use interest rate
futures to accomplish his objective and collects the information in Exhibit 2. The risk-free rate is
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