Reserve Bank of Australia (RBA) - Treasury Bonds - Zero-Coupon Yields (ZCY) - Finance Assessment Answer

Question 1 

As at August 2019 the Reserve Bank of Australia (RBA) had decreased the cash rate twice in 2019. This has seen bonds trade at lower yields to maturity (YTM). Roosters Bond Trust would like to explore the potential profitable trading opportunities available to them. They first need to obtain the true prices of Treasury bonds and their yield to maturities (YTM). Note: The EXCEL spreadsheet for Lecture 7 provides a simple example of bond pricing using ZCYs and calculating YTMs.

1. Provide and explain in your own words two reasons why the RBA decreased the cash rate in June 2019. Note: The RBA’s website provides information on the decrease.

2. Spring2019_AssignmentPart2Data.xlsx contains information on twenty (20) Treasury Bonds and twenty (20) zero-coupon yields (ZCY). The Treasury Bonds pay coupons semi-annually and their face value is $100.

3. Estimate the prices to 4 decimal places of the twenty (20) Treasury bonds. 

Plot a curve of the 20 Treasury bond’s YTMs and a curve of the ZCYs. Yields should be on the vertical axis and the terms on the horizontal axis. Explain why there are differences between the two curves.

• The 18-month zero-coupon bond (ZCB) with a face value of $100 is trading at $99.50. 
• Explain if the bond is mispriced or not mispriced.Construct an arbitrage portfolio using three Treasury bonds with a maturity of 18 months or less and the 18-month ZCB. In a labelled table show the number bought/sold and the dollar amounts of each of the four bonds that are in the arbitrage portfolio. Show how the arbitrage profit is made. (worth 1 mark). Note: The Cash Matching pdf and EXCEL spreadsheet illustrate how to construct a hedging portfolio. When there is mispricing the same method can be used to construct a profitable arbitrage portfolio.
• In your own words describe the trades used to create this arbitrage portfolio and why the portfolio will be profitable.

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