Consider an economy with three periods, t = 0, 1, 2. There are two bonds in...
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Consider an economy with three periods, t = 0, 1, 2. There are two bonds in this economy with the following payoffs Bond A has t = 0 price of $99, with a coupon rate of 10% and par value $100. Interest payments are made annually. Bond B has t = 0 price of $105, with a coupon rate of 30% and par value $100. Interest payments are made annually. Both bonds mature at t = 2. (1) Is there an arbitrage opportunity by trading those bonds? (3p) (2) Find an arbitrage portfolio if arbitrage exists. (3p) (3) Now suppose t = 0 price of Bond B is 120 instead of 105. Is there arbitrage? (3p) (4) Following part 3, can you create a portfolio with payoff of (120 190) and what is the t=0 price of this portfolio? (3p) Consider an economy with three periods, t = 0, 1, 2. There are two bonds in this economy with the following payoffs Bond A has t = 0 price of $99, with a coupon rate of 10% and par value $100. Interest payments are made annually. Bond B has t = 0 price of $105, with a coupon rate of 30% and par value $100. Interest payments are made annually. Both bonds mature at t = 2. (1) Is there an arbitrage opportunity by trading those bonds? (3p) (2) Find an arbitrage portfolio if arbitrage exists. (3p) (3) Now suppose t = 0 price of Bond B is 120 instead of 105. Is there arbitrage? (3p) (4) Following part 3, can you create a portfolio with payoff of (120 190) and what is the t=0 price of this portfolio? (3p)
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Answer rating: 100% (QA)
1 To determine if there is an arbitrage opportunity we need to compare the present value of the cash flows from each bond with their current prices Fo... View the full answer
Related Book For
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
Posted Date:
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