Question

A Commercial Paper Note with a face value of $500,000 and 113 days to maturity is selling a bank discount ask yield of 1.97%. What is the price of the bill? What is the bond equivalent yield?

In the case of Canary Wharf, London – Europe’s financial centre, the developer – Olympia & York, used Commercial Paper to help finance the project. Explain “maturity bunching” and “refinancing risk”. marks

Answer 1

Bank discount basis = (F - P) / F x (360 / n)

1.97% = (500,000 - P) / 500,000 x 360 / 113

Hence, price of the bill = P = 500,000 x (1 - 1.97% x 113/360) = $ 496,908

The bond equivalent yield = (F - P) / P x (365 / n) = (500,000 - 496,908) / 496,908 x (365 / 113) = 2.01%

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Maturity bunching refers to the phenomenon of bunching debts with similar maturities in one maturity class. So, the total debt is partioned in different maturity classes, and debts with similar maturities are bunched in that debt class. This is done mostly for the purpose of approximation and quick analysis.

Refinancing risk refers to the risk that an individual or an organization will not be able to refinance its ongoing obligation sometime in future, when the need be. This means that the borrower will not be able to replace the existing debt obligation with a new one, at some critical time in future.