Case Objective

To understand the time value of money; to understand the cash flows from T-notes and T-bills quotations and to determine the prices of Treasury securities given a set of possible spot rates.

Time value of money; quotations; discounting; bond prices and interest rates.

In this case, there are 2 securities. The market lasts for two periods. The first security is a a T-note with a face value equal to $5,000 while the second is a T-bill with a face value of $10,000. You can trade T-notes in units of $5,000 face value and T-bills in units of $10,000 face value. In addition the T-note has a coupon rate equal to 5% payable semi-annually (2.5% per 6-months). The cash flow from each bond at the end of each period is shown in the table below. The FTS market is open for trading at the beginning of each 6-month period only and you can assume that accrued interest is zero for the T-note.

The interest rate is initially 3% for 6-months (i.e., 6% annualized). In period 2, it is either 2% or 3% (i.e., 4% or 6% annualized). If you have any cash left at the end of trading period 1 it is automatically invested in the money market at 3% for the remaining 182-days. If you have cash left at the end of trading period 2 it earns either 2% or 3% (equally likely) for the remaining 183-days. Borrowing is allowed at these rates.

You can sell bonds short. If you are short and don’t cover your position, you will have to pay any coupons and/or face value on the security at the end of the period. All traders have primary dealer status.

The cash flows and quotation system for the securities are:

Case Objective

To understand the cash flows from T-bills, quotations and to determine the arbitrage free prices of interest rate caps and floors.

Time value of money; quotations; discounting; T-bill, caps and floor prices and interest rates.

In this case, there are 4 securities. The market lasts for three 3-month periods but you can only trade at the beginning of the first two quarters. Your position carries over to quarter 3 and is marked-to-market without further trading. On the screen this appears as a third trading period that opens and immediately finishes. The first security is a T-bill with a face value equal to $10,000 maturing 2-periods (i.e., 182-days) after the start. The second security is a T-bill with a face value of $10,000 maturing 3-periods (i.e., 273-days) after the start . The third is an interest rate cap with a principal equal to $100,000, strike rate 6% per annum and life equal to 91-days. The fourth security is an interest rate floor with a principal equal to $100,000, strike rate 6% per annum and a life of 91-days. Both the interest rate cap and floor pay settle in cash at the end of the second quarter. The FTS market is open for trading at the beginning of the first two quarters. No trading is permitted at the beginning of the third quarter instead your position is marked-to-market at the end of the third quarter.

The interest rate is initially 1.5% for 3-months (i.e., 6% annualized). In quarter 2, it is either 1% or 2% (i.e., 4% or 8% annualized), and in quarter 3 it is either 0.6667%, 1.3333% or 2.6667%. If you have any cash left in any trading period it is automatically invested in the money market at realized spot rate. Borrowing and shortselling is allowed at realized spot rates. Finally, all realizations are equally likely.

The cash flows and quotation system for the securities are:

Trading Objective

As a primary dealer your aim is to make money and maintain liquid markets.

Bond Tutor Support System

You can check the implied yield-to-maturity (YTM) for your quotation by using Bond Tutor as your trading support system.

Note: At the beginning of the second period change days to maturity to equal 183

Trading Crowd

You are all dealers in this market. This gives you the right to post bids and asks. For convenience these are collected together in a centralized FTS market book. Your trading screen will show the results of the best bid/ask posted by dealers at any point in time. In addition, you can look at the central FTS book by clicking on the menu item Support then the sub-menu item Limit Order Book:

Note: Increasing T-bill bids: 4.54/50, 4.50/45, 4.35/45 (note discount yields must decrease)

Decreasing T-bill asks: 4.25/50, 4.27/45, 4.30/99 (note discounts yields must increase)