a) In January 2018, an Australian fund manager buys a USD 10 million parcel of 4.20% (coupon) January 2019 bonds at a yield of 5%. The bonds have a face value of USD 100. The coupons are paid annually. The January 2018 coupon was already paid to the previous owner. Calculate the price paid for the parcel of bonds.
b) Name the two most important types of risks that the aforementioned fund manager faces with this specific investment and explain how she can hedge at least one of the risks.
A FX dealer provides a quote of AUD/USD 0.7345–53. (Hint: AUD/USD is stating how much 1 AUD buys in the foreign currency.) c) An Australian fund manager wishes to convert AUD into 10 million USD to invest in US bonds. If she accepts the dealer’s quote, how much in AUD will she pay?
Answer to Part (a):
| A. | Yield at the time of purchase | 5% |
| B. | No. of Bonds (C/D) | 100,000 |
| C. | Face Value of Bonds | $10,000,000 |
| D. | Face Value per Bond | $100 |
| E. | Coupon Rate | 4.2% |
| F. | Coupon Payment in 2019 (E x C) | $420,000 |
| G. | Redemption Amount (=C) | $10,000,000 |
| H. | Total Cashflows after 1 year (F+G) | $10,420,000 |
| I. | Price Paid now [H/(1+A)] | $9,923,810 |
Answer to part (b)
Two Risks are:
Currency Fluctuation Risk
Counterparty Default Risk
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