Question

3. Read the following quote the rom Bank of Namibia June 2020 Quarterly bulletin and answer the questions that follow: “The demand for shorter-term fixed-rate treasury bonds was strong during the first quarter of 2020 and yields on short to medium bonds declined by more than 50 basis points. “

3.1. Define “bond yield” (2)

3.2. Briefly explain why strong demand for short term bonds lead to a decline in the yield on short term bonds. (2)

4. Explain what is meant by “put-call parity” and write down the equation expressing put-call parity, clearly indicating the meaning of the components of the equation (5)

Answer 1

A) Bond yield refers to the percentage return investor realizes when he invests in the bond based upon the maturity cash flow and the interest receipt over the maturity. It is based upon the purchase price, coupon and the maturity value.

B) A strong demand for an asset pushes the price up. Similar is the case with bonds. When there is high demand, the purchase price goes up but the maturity value and the coupon remains constant which lowers the bond yield.

4.) Put call parity is defined as principle that defines the relation between the put and call option of the same underlying, same strike price, and same expiration date.

Equation is given by C + PV(X) = P + S

Where C is the lrice or premium of the call option

PV(X) is the present value of the strike price chosen discounted from the expiry date at risk free rate

P is the price or premium of the put optio

S is the current or spot price of the underlying.