Suppose that bond ABC is the underlying asset for a
Suppose that bond ABC is the underlying asset for a futures contract with settlement six months from now. You know the following about bond ABC and the futures contract: (1) In the cash market ABC is selling for \$80 (par value is \$100); (2) ABC pays \$8 in coupon interest per year in two semiannual payments of \$4, and the next semiannual payment is due exactly six months from now; and (3) the current six-month interest rate at which funds can be loaned or borrowed is 6%.
Answer the below questions.
(a) What is the theoretical futures price?
(b) What action would you take if the futures price is \$83?
(c) What action would you take if the futures price is \$76?
(d) Suppose that bond ABC pays interest quarterly instead of semiannually. If you know that you can reinvest any funds you receive three months from now at 1% for three months, what would the theoretical futures price for six-month settlement be?
(e) Suppose that the borrowing rate and lending rate are not equal. Instead, suppose that the current six-month borrowing rate is 8% and the six-month lending rate is 6%. What is the boundary for the theoretical futures price?
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