You work for an underwriter. The underwriter asks you to ¡§strip¡¨ a portfolio of treasury bond. The treasury bonds in question are all identical, they have 5 years to maturity, pay an annual coupon of 7.25% per year, payable annually, and they are currently selling at face, at $ 100 million.

The strips you intend to issue are not the standard interest only (IO) and principal only (PI) strips, but rather different.
Both strips mature in 5 years as well. Each strip has a face of 50 MM. The coupons on both strips depends on an appropriately chosen index of general interest rates.
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To calculate the coupon rate on the strips, you'll need to determine the appropriate index of general interest rates. This index will help you estimate the future interest rates on the strips. The underwriter should provide you with guidance on which index to use. Once you have that information, you can proceed to calculate the coupon rates.

Here's how you can calculate the coupon rates on the strips:

1. Determine the index value: Look up the current value of the chosen index of general interest rates. Suppose the index value is 3.5%.

2. Calculate the coupon rates: The coupon rates on the strips will be based on the index value. Let's assume the underwriter wants a margin of 1% above the index for both strips.

a. For the first strip: Add the index value (3.5%) and the margin (1%) to get a coupon rate of 4.5%. Therefore, the coupon payment on this strip will be 4.5% of the face value ($50 million) annually for the next 5 years.

b. For the second strip: Add the index value (3.5%) and the margin (1%) to get a coupon rate of 4.5%. However, the underwriter may want to offer a different coupon rate for the second strip. Let's assume they want to give a lower coupon rate of 3.5%. In that case, the coupon payment on this strip will be 3.5% of the face value ($50 million) annually for the next 5 years.

Please note that the specific calculations may vary based on the underwriter's instructions, the chosen index, and any additional factors they may consider. It is important to communicate with the underwriter to ensure accuracy in determining the coupon rates for the strips.