A bond promises a risk-free payment of $1000 in one year. The risk-free rate of interest is
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Question:
A bond promises a risk-free payment of $1000 in one year. The risk-free rate of interest is 2.64%.
a) What is the price of the bond?
b) If the price of the bond is actually $960, what is the arbitrage strategy? Illustrate all cash flows
today and one year from today.
c) If the price of the bond is actually $990, what is the arbitrage strategy? Illustrate all cash flows today
and one year from today.
Hint: you are able to borrow money from the bank, or deposit money into the bank, at the risk-free
rate of interest. After one year you will pay back your loan plus interest, or receive your savings plus
interest.
Related Book For
Business Statistics Communicating With Numbers
ISBN: 9780078020551
2nd Edition
Authors: Sanjiv Jaggia, Alison Kelly
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