Problem A . Construct a Replicating P ortfolio (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. Wha t is the dollar f ace value of Bond -1 in the RP?

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

3. Wh at is the dolla r 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.

Show all work on how to get these answers

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