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A dealer in government securities is considering b...

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A dealer in government securities is considering buying $875 million in 10-year Treasury notes and $1,425 million dollars in 6-month Treasury bills. Current yields on the T-notes average 7.15 percent, while 6-month T-bill yields average 3.28 percent. The dealer can currently borrow $2,300 million through one-week repurchase agreements at an interest rate of 3.20 percent. Compute the dealer?s expected carry income in each of the following scenarios. (Hint: A spreadsheet can be most useful here. Perform the succession of calculations for the T-note in row 1; the succession of calculations for the T-bill in row 2; and the expenses from the RP in the row 3. Then, compute the carry income from the appropriate columns where income and expenses have been computed for each scenario.) a. The dealer purchases the T-notes and T-bills and finances them with the RP under the terms listed above. b. Same as part (a) above except that interest rates change to 7.30 percent on the T-notes, 5.40 percent on the T-bills and 5.55 percent on the RP, and the dealer must refinance the T-note and T-bill purchases at the new RP rate. c. Same as part (b) above except the dealer had not purchased the T-notes and T-bills until after interest rates changed. d. Repeat part (b) in the case where rates changed to 7 percent on the T-notes, 5.10 percent on the T-bills, and 4.5 percent on the RP. e. Repeat part (b) except the dealer had not purchased the T-notes and T-bills until after the interest rates changed. f. Based on the above results, is it always good for the dealer when interest rates rise? How about when they fall? Please explain. g. Could the dealer have benefited by a short position in case (b) or (d) above? Please explain.

 

Paper#7180 | Written in 18-Jul-2015

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