MFIN6003 Derivative Securities Dr.

Huiyan Qiu

Solution to Exercise_Session One

Solution to in-class exercise I (1-30):
5% semi-annual compounding → (1 + 5%/2)2 – 1 = 5.06% effective
annual interest
To result in the same effective annual interest
a) Annual compounding:
1 + 𝑟 = (1 + 5%/2)2 → r = 5.06%
b) Monthly compounding:
(1 + 𝑟/12)12 = (1 + 5%/2)2 → r = 4.95%
c) Continuously compounding:
𝑒 𝑟 = (1 + 5%/2)2 → r = ln(1.0252) = 4.94%

Solution to the in-class exercise II (1-31):

Let x denote the amount of money your grandparents put into the
account when you were born. Then we have the following:
𝒙 × 𝟏. 𝟎𝟒𝟐𝟐 = 𝟐𝟑, 𝟔𝟗𝟗
Solving the equation, we have 𝑥 = 10,000. The amount of money
your grandparents put into the account when you were born is
$10,000.
The amount of money in the account on your 32nd birthday:
$10,000 × 1.0432 = $𝟑𝟓, 𝟎𝟖𝟎. 𝟓𝟗
(23,699 × 1.0432−22 = $35,080.31)
The amount of money in the account on your 65th birthday:
$10,000 × 1.0465 = $𝟏𝟐𝟕, 𝟗𝟖𝟕. 𝟑𝟓
(23,699 × 1.0465−22 = $127,986.34)

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MFIN6003 Derivative Securities Dr. Huiyan Qiu

Solution to the in-class exercise III (1-32):

Following table shows the time and the cash flows the bond holder
will receive in the future (per 100 face value):

The price of a security is the present value of all future cash flows.
Therefore,
𝐁𝐨𝐧𝐝 𝐏𝐫𝐢𝐜𝐞
2 2 2 2 2 102
= + + + + +
1.025 1.0252 1.0253 1.0254 1.0255 1.0256
= 𝟗𝟕. 𝟐𝟒𝟓𝟗
(In bond market, yield is quoted bond-equivalent basis. It means that the quoted
annual yield has the same compounding frequency as the coupon payment. In this
exercise, coupon is paid semi-annual. Therefore, the 5% bond yield is also semi-
annual compounding.)