Question #37

of 79 Prices of zero-coupon, $1 par bonds is shown below: Maturity (years) Price 1 $0.9615 2 $0.9070 3 $0.8396 4 $0.7629 The default risk of these bonds is similar to the default risk of surveyed banks based on which the swap rate is determined. Government yield curve is given below: Maturity (years) Rate 1 3.05% 2 4.10% 3 5.25% 4 6.45% The three-year swap spread is closest to: A) 67 bps. B) 78 bps. C) 110 bps. Lihua Zhou has recently been hired by Ragun Asset Management, and is currently working for the fixed income team. Zhou receives a communication from Cindy Roll, chief economist, and makes the following notes: Forecast 1: U.S. Federal Reserve is increasingly concerned with rising inflation and expected to tighten monetary policy during the next meeting. Forecast 2: The EU zone is expected to see a bullish flattening of the yield curve. Zhou notices that the firm's portfolio in the EU zone is almost exclusively medium remaining maturity (10-11 years) notes. Zhou attends an informal discussion group with colleagues who have also recently joined the firm. During their discussion, Amanda Eden, one of Ragun's risk analysts, made two comments: Comment 1: "There are lots of bond spreads, each with different bases. For instance, the spread I'm tracking at the moment measures the difference between the return on Treasury bills and the interest rate used to price the Eurodollar futures contracts." Comment 2: "If the spread widens, it's an indicator that risk in the banking system is increasing."