FINM7405 Assignment Part 1
FINM7405
Semester 1 2025
This assignment consists of 4 questions: two 15 mark questions (1 and 4) and two 10 mark
questions (2 and 3). You must complete all questions. The total marks are 50. The assign-
ment composes 25% of your final assessment. Feel free to ask questions of your tutors or me.
I will be available on Slack most nights. There is no word count other than where mentioned.
You should use the APA referencing style where appropriate. You can find details here.
1 Portfolio Valuation and Sensitivity Analysis
You manage the following portfolio of fixed income assets at time t = 0:
Instrument Face Value ($) Coupon Rate Time to Maturity Type
A 1,000,000 5.00% 3 years Coupon Bond
B 500,000 0% 1 year and 12 days year Zero-Coupon Bond
C 2,000,000 3.00% 5 year and 120 days Coupon Bond
D 300,000 - 64 days Bank Accepted Bill (BAB)
E 1,500,000 0% 7 years Zero-Coupon Bond
F 500,000 - 120 days Treasury Note
Yield Curve Information
The following yields (expressed as annual rates, compounded semi-annually) apply before
the yield curve shift:
Maturity (Years) Yield
0.25 4.00%
0.5 3.70%
1 4.20%
3 4.50%
5 3.80%
7 5.20%
Each instrument should be valued using the closest yield available for its maturity. After the
parallel shift, all points on the yield curve are assumed to increase by 1% (100 basis points).
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Yield Curve Diagram
The original and shifted yield curves are illustrated below:
Maturity (Years)
Yield (%)
Shifted (+1%)
Original
1. Portfolio Valuation (4 Marks)
(a) Calculate the current market value of each instrument:
• For coupon bonds: discount all cash flows using semi-annual compounding
yields.
• For zero-coupon bonds: discount the lump sum using the appropriate yield.
• For BABs and Treasury Notes: use simple discount formulas based on the
given yields.
Find the total portfolio value.
2. Duration and Convexity (4 Marks)
(a) Calculate the Macaulay Duration and Modified Duration for bonds A, C, and E.
(b) Calculate the portfolio’s weighted average Modified Duration. Assume BABs and
Treasury Notes have duration equal to their maturity and zero convexity.
(c) Calculate the Convexity for bonds A, C, and E, and the portfolio Convexity.
Assume BABs and Treasury Notes have duration equal to their maturity and
zero convexity.
3. Impact of Parallel Yield Curve Shift (4 Marks)
(a) Suppose the entire yield curve shifts upward by 1% (100bps) today. Using the
portfolio’s Modified Duration only, estimate the percentage and dollar change in
portfolio value.
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(b) Using both Modified Duration and Convexity, refine your estimate.
(c) Revalue the portfolio using the new yields and calculate the actual change in
portfolio value. Compare with your estimates.
4. Discussion (3 Marks)
(a) How well did the Modified Duration predict the actual change?
(b) How much improvement came from incorporating Convexity?
(c) Why are short-term instruments like BABs and Treasury Notes less sensitive to
yield changes?
2 Exploring Options on Treasury ETFs: IEF
The iShares 7–10 Year Treasury Bond ETF (ticker: IEF) is an exchange-traded fund that
tracks the investment results of an index composed of U.S. Treasury bonds with remaining
maturities between 7 and 10 years. As such, IEF serves as a liquid, tradable proxy for the
intermediate segment of the U.S. government bond market. Options on IEF allow investors
to take leveraged directional views on Treasury yields or to hedge duration exposure.
Task: Go to the following website to access current option chain data for IEF:
https://finance.yahoo.com/quote/IEF/options
Using data for both calls and puts across all available strike prices and expiry dates, complete
the following:
1. Strike Price vs. Option Price (3 Marks)
For both calls and puts, create a scatter plot of option market price (Y-axis) against
strike price (X-axis). Include all available contracts across all expiries.
Explain: Describe the observed relationship. Why do some options cost more than
others? How does the moneyness affect option value?
2. Time to Maturity vs. Option Price (3 Marks)
For both calls and puts, create a scatter plot of option price (Y-axis) against time to
maturity in days (X-axis). Use all available strike prices and expiries.
Explain: What is the relationship between maturity and price? Does the increase in
time always lead to a higher price?
3. Liquidity Analysis (4 Marks)
For both puts and calls, examine the open interest and volume fields. Where is
market activity concentrated — near-the-money, deep in- or out-of-the-money, short-
term or long-term expiries?
Diagram: Create a diagram (e.g., heatmap, bar chart, or annotated strike graph)
that illustrates where the most liquid contracts are found. Comment on the pattern
and its implications for trading and hedging. Explain why this is.
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3 Analyzing Treasury ETFs: SHY, IEI, IEF, TLH, and
TLT
iShares (BlackRock) offers a series of U.S. Treasury bond ETFs that allow investors to access
specific maturity segments of the yield curve with high liquidity and low cost. These ETFs
invest directly in U.S. Treasury securities and aim to closely track the performance of their
target maturity range. They provide investors with simple tools to manage interest rate
exposure, duration risk, and macroeconomic positioning.
The ETFs are:
• SHY: Tracks the performance of U.S. Treasuries with maturities between 1 and 3
years. Designed to capture short-term interest rate movements with minimal duration
risk.
• IEI: Tracks 3–7 Year U.S. Treasuries. Intermediate short-term exposure, balancing
yield pickup with moderate interest rate sensitivity.
• IEF: Tracks 7–10 Year U.S. Treasuries. Represents longer intermediate maturity
bonds, more sensitive to yield curve shifts than SHY or IEI.
• TLH: Tracks 10–20 Year U.S. Treasuries. Bridges the gap between standard interme-
diate and ultra-long bonds, providing significant duration exposure.
• TLT: Tracks 20+ Year U.S. Treasuries. Highly sensitive to changes in interest rates
and long-term economic expectations, making it a duration-heavy investment.
All of these ETFs:
• Hold portfolios of real Treasury bonds matching the target maturity range.
• Are passively managed and rebalanced to maintain their maturity profile.
• Are highly liquid and widely used for hedging, duration management, and tactical bets
on interest rates.
Task: Go to a credible financial data source (e.g., Yahoo Finance, Bloomberg, etc) to retrieve
recent price performance data for SHY, IEI, IEF, TLH, and TLT.
Using the available information, complete the following:
1. Recent Performance Analysis (3 Marks)
Retrieve the price performance of each ETF over the past 6–12 months. Present a
comparison of their returns. You may use a line chart or a table summarizing total
returns and price movements.
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2. Geopolitical Interpretation (3 Marks)
Analyze the differences in returns across these ETFs. How have recent geopolitical
events (e.g., conflicts, elections, macroeconomic shifts, global inflation concerns) con-
tributed to the movements observed? Why might short-duration funds react differently
than long-duration funds in such environments?
3. Five-Year Portfolio Construction (4 Marks)
Imagine you must invest your entire portfolio solely across these five ETFs for the next
five years. How would you allocate your investments among SHY, IEI, IEF, TLH, and
TLT? Justify your proposed allocation based on:
• Your forecast for future interest rates and inflation.
• Your assessment of geopolitical risks and macroeconomic uncertainty.
• Your appetite for duration risk and portfolio volatility.
• Your views on yield curve movements (e.g., steepening, flattening).
4 Lehman Brothers
Why did they fail? (15 Marks)
Using some of the things we learned in lectures as well as your own research, answer the
following:
• Explain what was happening in the wider economy, that led to the financial crisis?
• Explain the process of securitization and why it was so popular.
• What happened to Lehman Brother’s involvement in the market for mortgage backed
securities through the early 2000s?
• Critique their risk management processes.
In your answer, it is suggested that you use academic papers, financial reports, and reputable
news sources as references. This is an effort question, in that you can feel free to investigate
individual elements of the crisis and Lehman Brothers in detail. You will be marked on the
amount of effort you put in, as well as your reasoning, not necessarily everything that is
relevant to the question.
Minimum Words: 1000
Note: Please attach any plots, data tables, or calculations you use. State clearly any
assumptions you make about future economic or market conditions.
Deliverables:
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• Excel file showing calculations (pricing, duration, convexity, and value change analysis).
Use a different tab for each question.
• A pdf file with answers to all questions including diagrams generated in excel.
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