Construct a Replicating Portfolio (RP) to replicate a 1.5 -year Bond- 0 that pay s A1 percent of coupon per year. The available bonds for replication are : a one year zero coupon Bond- 1, a 1.5 -year Bond- 2 that pay s A2 percent coupon per year , and a 1- year Bond -3 which pays A3 percent coupon per year. All the bonds (Bond- 0, Bond- 1, Bond- 2, and Bond- 3) have the same face value of $100 and pay their annual coupons two times a year. Compute an arbitrage trading strategy to generate profits, if any, when the current market prices of the four bonds, respectively, are A4, A5, A6 and A7.

1. What is the dollar f ace value of Bond -1 in the RP?

2. What is the dollar face value of Bond- 2 in the RP?

3. What is the dollar face value of Bond- 3 in the RP?

4. What is the cost of the RP?

5. What is the arbitrage fair price of Bond- 0?

6. Write 1 if Bond- 0 is to be held long and 0 if Bond- 0 is to be held short in arbitrage trading strategy.

7. Write 1 if Bond- 1 is to be held long and 0 if Bond- 1 is to be held shortly in an arbitrage trading strategy.

8. Write 1 if Bond- 2 is to be held long and 0 if Bond- 2 is to be held shortly in an arbitrage trading strategy.

9. Write 1 if Bond- 3 is to be held long and 0 if Bond- 3 is to be held shortly in an arbitrage trading strategy.

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A1	A2	A3	A4	A5	A6	A7
6.3	4.3	8.3	100.3	97.85	100.08	102.36

Answer rating: 100% (QA)

Lets summarize the payoffs from the given bonds in a table with respect to time ALso lets say we need P Q R numbers of Bond 1 2 3 to replicate Bond 0 Please see the table below Payoff at time 05 year ... View the full answer