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Question 10 (Total = 8 marks). Suppose that an investor (denoted "Investor 1") calculates the spread of a particular bond, S, based on the past 300 trading days, to be distributed normally with a mean of 0.03% and a standard deviation of 0.04%. Note that the spread of a bond on a particular day is dened to be S = M T where M is the yield to maturity used by the market on that day and T is the yield to maturity the investor believes should be used to price the bond on that day. Now suppose that another investor (denoted "Investor 2") attempts to use rich-cheap analysis to price the same bond. This investor calculates the spread, based on the past 300 trading days, to be distributed normally with a mean of -0.02% (note that this is a negative number) and a standard deviation of 0.03%. Also we dene U = 82: where m and o- are the mean and standard deviation of 5 respectively for a particular investor and both investors use U to transform their spread distribution. (a) (2 marks) In your own words, explain what is meant by rich-cheap analysis. (b) (3 marks) Suppose that on a given day, the yield to maturity of a bond, based on observed bond prices, is 5% pa nominal. Investor 1 believes the yield to maturity for this bond on this day should be 4.88% (using their valuation model) while Investor 2 believes the yield to maturity for this band should be 5.06%. By performing appropriate calculations, calculate whether investor 1 would trade with investor 2. HlNT: For each investor, calculate when they would buy or sell the bond based on their own individual spread distribution. (c) (3 marks) What risks are there in implementing rich-cheap analysis? How are these overcome in practice in the implementation of the strategy