Construct a Replicating Portfolio (RP) to replicate a 1.5-year

Bond-0 that pays 14.59 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 pays

12.59 percent coupon per year, and a 1-year Bond-3 which pays 16.59 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 108.59, 93.7, 102.15 and

112.31.

1. What is the dollar face 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 short

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 short

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 short

in an arbitrage trading strategy.