Investments

1. A 5-year bond with face value $1,000 (paid at maturity) and coupon rate 5%

(coupon paid in arrears annually) has yield-to-maturity 4.5%. What is the

convexity of the bond?

2. Assume that stock returns follow a 2-factor structure. The risk-free return is

3%. Portfolio A has average return 8% and factor-betas 0.7 and 0.9 (for

factor 1 and 2, respectively). Portfolio B has average return 10% and factor betas 1.2 and 1.1 (for factor 1 and 2, respectively). What is the average

return for portfolio C that has factor-betas 1 and 1 (for factor 1 and 2,

respectively)?

Sample Solution