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Investment / Financial Markets Old Exam MFE Forum

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  #1  
Old 09-28-2018, 05:37 PM
umites umites is offline
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Join Date: May 2014
Posts: 17
Default ASM Exercise 1.4

Apparently, I have a long road ahead, because I don't understand the fourth exercise of the first chapter.

Exercise:
A 3-year zero-coupon bond with maturity value 1000 has annual effective interest 6%. The bond is short-sold, with collateral 110% of its value. After one year the position is closed. At that time, the annual effective interest rate for the bond is 7%. There are no commissions paid when buying or selling. The interest rate paid on the loan to provide the collateral is 6%. Net profit at the end of one year is 7.32.
determine the repo rate


What does the bold sentence mean? Here's what I know:
  • Short seller sells bond at t=0 for $839.62, and buys it back at t=1 for $873.44, losing $33.82
  • Short seller pays 0.06*0.1*$839.62 = $5.04 in interest on the 10% haircut
  • Collateral is 1.1*$839.62 = $923.58

Where does $7.32 come from? Who is making a net profit of $7.32 at the end of one year and why? It doesn't seem like the short-seller or the lender gets $7.32 at the end of the year, so I'm not sure what the question is saying here.
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Old 09-30-2018, 02:19 PM
Abraham Weishaus Abraham Weishaus is offline
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The short-seller earns interest on the collateral. At what rate? You know that he made 7.32, so you can back out the rate.
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Old 09-30-2018, 05:11 PM
umites umites is offline
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Got it, thanks!
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