Suppose that at time 0: (1) a 2-year annual coupon bond with 4% coupon rate trades at par, and (2) a 2-year zero coupon bond with face value $100 trades at $97. Denote P the time 0 price of a bond with the following risk-free cash flows:

Year 1 cash flow = $100 

Year 2 cash flow = $100 

a. Suppose there are no transaction costs. Then the price must be P=$____. (replicating portfolio)

Suppose that each bond must be traded through a different broker, and each broker requires a fixed fee of $1 per short transaction, irrespectively of the size of the transaction. There are no transaction costs for buying. 

b.The minimal price possible price is P= ?

c. The maximal price possible price is P= ?

Answer rating: 100% (QA)

a To find the price of the bond with the given cash flows we can use the concept of a replicating portfolio Since the bond pays 100 at the end of each ... View the full answer