Question: Question 2 (33 marks) There are 3 bonds in the market: Bond A B C Coupon rate (%) 0 Maturity YTM (%) 1 8

Question 2 (33 marks) There are 3 bonds in the market: Bond

Question 2 (33 marks) There are 3 bonds in the market: Bond A B C Coupon rate (%) 0 Maturity YTM (%) 1 8 9 7 2 7 2 9 Coupon payments are annual and bid-ask spreads are zero. a) What are the prices of the above bonds? (6 marks) b) Is it possible to construct an arbitrage strategy by replicating the cash flows of bond B using bonds A and C? If so, what is the trading strategy that will produce $5000? (10 marks) c) You are offered three investment opportunities. The cash flows of the three investments are reported in the table below: Projects A B Time 0 1 3,000 600 -8,000 12,000 5,000 -3,000 C Find the range of the discount rate that ensures project B is better than projects A and C. (6 marks) d) Plot the present value of the three investments against the values of the discount rate. Clearly label the values on the vertical (i.e., present value) axis and the range calculated in part c. (11 marks)

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