Hull -Interest Rates Problem 4.16

[Adelaide]

Hi, can someone please explain the cash flows in Year 10 here (problem 4.16):
Year 10: 200-100 = 100

Thanks...

 

[Alex_1]

Hi @MayaH, I'm also currently working on Hull's T3 Practice Questions, but I can't seem to find any problem "4.16" for Hull's Interest Rates. Maybe you could point at the page number/document name or provide some details from the question text? Thanks.

 

[David Harper CFA FRM]

In Hull's problem 4.16 (@Alex_1: @MayaH refers to the actual textbook question), you are given two coupon bonds. By creating a portfolio that is long two bonds with 4% coupons plus short one bond with 8% coupon, you neutralize the coupon cash flows (i.e., if annual, each year 1 to 9, you receive 2*40 = $80 and pay $80). What remains is a synthesized zero coupon bond with only two cashflows:

• Year 0: receive $90 for the short - (2 * 80) for the two longs = -70; based on prices given; and
• Year 10: receive 2*100 = $200 for return of principal on the two long bonds - $100 for payment of principal on the one short bond = $100.

 

[Adelaide]

Many thanks, David!!!