For risk-free rate R f use YTM of the following 10-year T-bond, prices are taken on 12.10.2022
Question:
For risk-free rate Rf use YTM of the following 10-year T-bond, prices are taken on 12.10.2022
Maturity | Coupon | Bid | Ask | Yield |
11/15/2032 | 4.125% | 104.212 | 104.212 | 3.489% |
For market risk premium (Rm – Rf), use 6%
Consider the following STRIP Bonds, and calculate the YTM/Spot rates, assuming the settlement date is 12/10/2022:
Maturity | STRIP Price | YTM/spot rate |
6/15/2023 | 96 | 8.507% |
12/15/2023 | 92 | 8.696% |
6/15/2024 | 89 | 8.079% |
12/15/2024 | 85 | 8.465% |
6/15/2025 | 81 | 8.794% |
12/15/2025 | 75 | 10.064% |
6/15/2026 | 70 | 10.728% |
12/15/2026 | 68 | 10.122% |
6/15/2027 | 65 | 10.046% |
12/15/2027 | 63 | 9.681% |
6/15/2028 | 58 | 10.411% |
12/15/2028 | 55 | 10.477% |
A.) An insurance company projects claims of $250m, $300m, and $500m, 3, 4, and 5 years later. If the company wants to match the projected liabilities with STRIPs, how much would the strategy cost today? Will the strategy protect the company from cash-flow risk?
B.) Using the above spot rates, what is the price of a 5-year, 4.5% bond? Assume semiannual interest payments. What is the YTM of the 5-year T-bond?
C.) If the 5-year T-bond is selling for 110, is there an arbitrage opportunity?
D.) How much is the arbitrage profit? What are the required trades to exploit the arbitrage opportunity?
Expert Answer:
