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 Financial Mathematics Old FM Forum

#41
10-14-2006, 01:51 AM
 krzysio Member SOA AAA Join Date: Mar 2005 Location: Bloomington, Illinois Favorite beer: Tyskie Posts: 1,321
Exercise for October 14, 2006

It is posted at:
http://www.math.ilstu.edu/krzysio/KO-FM-Exercise74.pdf

Yours,
Krzys' Ostaszewski
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#42
10-16-2006, 11:41 AM
 yesactuary Member SOA Join Date: Nov 2005 Posts: 426
a question on the Practice exam 5 #21 (December 2005 edition)

This is a premium bond because the coupon rate is 4%, which is greater than i, where the interest i=3.5%. Since it's a premium bond, we want the redemption date to be the earliest possible date, right? I don't understand why the answer isn't 111.25 (t=10)? Thank you!
#43
10-16-2006, 11:48 AM
 MyKenk Note Contributor CAS AAA Join Date: Nov 2005 Location: twitter.com/mykenk College: Drake '06 Posts: 8,595

well, I have no idea what the question is, but... are the redemption values equal? the Premium Early, Discount Late rule only is guaranteed with equal redemption values...
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#44
10-17-2006, 03:56 PM
 krzysio Member SOA AAA Join Date: Mar 2005 Location: Bloomington, Illinois Favorite beer: Tyskie Posts: 1,321

Quote:
 Originally Posted by yesactuary This is a premium bond because the coupon rate is 4%, which is greater than i, where the interest i=3.5%. Since it's a premium bond, we want the redemption date to be the earliest possible date, right? I don't understand why the answer isn't 111.25 (t=10)? Thank you!
The call price is not par, but at substantial premium. In your reasoning, you assume that the bond is called at par, and that is clearly not the case. The solution provided in the manual explains every step, could you please read it, and then tell me please where you stop understanding. I will try to help then.

Yours,
Krzys'
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#45
10-17-2006, 05:04 PM
 yesactuary Member SOA Join Date: Nov 2005 Posts: 426

Quote:
Originally Posted by krzysio
Quote:
 Originally Posted by yesactuary This is a premium bond because the coupon rate is 4%, which is greater than i, where the interest i=3.5%. Since it's a premium bond, we want the redemption date to be the earliest possible date, right? I don't understand why the answer isn't 111.25 (t=10)? Thank you!
The call price is not par, but at substantial premium. In your reasoning, you assume that the bond is called at par, and that is clearly not the case. The solution provided in the manual explains every step, could you please read it, and then tell me please where you stop understanding. I will try to help then.

Yours,
Krzys'
"For example, if the investor pays \$108 for the bond, this investor will make more than 3.5% if the bond is called before maturity, but will make less than 3.5% if the bond is held to maturity..."

I didn't understand this explanation in the solution, but I got it now. I like this problem. Thanks, Krzys'.

if price=111.25, c=100, Fr=4, n=20, then, i=3.22% < 3.5%.
if price=107.11, c=100, Fr=4, n=15, then, i=3.38% > 3.5%.
#46
10-19-2006, 10:03 AM
 yesactuary Member SOA Join Date: Nov 2005 Posts: 426
option-free bond?

Hi Krzys', could you explain to me what is option-free bond? Thank you again.
#47
10-19-2006, 10:05 AM
 MyKenk Note Contributor CAS AAA Join Date: Nov 2005 Location: twitter.com/mykenk College: Drake '06 Posts: 8,595

Quote:
 Originally Posted by yesactuary Hi Krzys', could you explain to me what is option-free bond? Thank you again.
Not 100% sure if this is common language, but from my memory, it's simply that, a bond with no options. Now, the only option that I can think that we would be responsible for is a call option, so my guess is that it's a bond that cannot be called prior to the redemption date. Does that match up with the context you see it in?

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#48
10-20-2006, 10:16 PM
 krzysio Member SOA AAA Join Date: Mar 2005 Location: Bloomington, Illinois Favorite beer: Tyskie Posts: 1,321
Option-free bond

Quote:
Originally Posted by mykenk
Quote:
 Originally Posted by yesactuary Hi Krzys', could you explain to me what is option-free bond? Thank you again.
Not 100% sure if this is common language, but from my memory, it's simply that, a bond with no options. Now, the only option that I can think that we would be responsible for is a call option, so my guess is that it's a bond that cannot be called prior to the redemption date. Does that match up with the context you see it in?

Yes, you are correct.
Yours,
Krzys'
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#49
10-20-2006, 10:17 PM
 krzysio Member SOA AAA Join Date: Mar 2005 Location: Bloomington, Illinois Favorite beer: Tyskie Posts: 1,321
Sugar-free, option-fee, etc.

Quote:
 Originally Posted by yesactuary Hi Krzys', could you explain to me what is option-free bond? Thank you again.
Just like sugar-free contains no sugar, option-free contains no options. Does that not make sense?

Yours,
Krzys' Ostaszewski
__________________
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#50
10-20-2006, 10:42 PM
 yesactuary Member SOA Join Date: Nov 2005 Posts: 426

Quote:
Originally Posted by krzysio
Quote:
 Originally Posted by yesactuary Hi Krzys', could you explain to me what is option-free bond? Thank you again.
Just like sugar-free contains no sugar, option-free contains no options. Does that not make sense?

Yours,
Krzys' Ostaszewski

so it's same as non-callable bond?