Please correct answer and don't use hand rating A fixed income arbitrage hedge fund focuses on Treasury bond trading. Bond A is a ten-yearTreasury bond (Notes) which was issued eight years ago in a low interest environment. BondB is a three-year Treasury bond (Notes) issued one year ago in a high interest environment.The two bonds have two years left to maturity each and the following coupon payments, facevalue and prices.t=1t=2Price at t=0Bond A:$2$2+$100$94.78Bond B:$4 $4+$100$96.43(a)Is there an arbitrage? [2p](b)(c)(d)(e)(f)If yes, find one arbitrage portfolio and determine the price and payoff of it. [3p]Another investor who understands arbitrage trading, asks the sales and trading team ofan investment bank to execute a trade of the two bonds such that he makes $100million at t=1 and $0 at t=2 without paying for it. How does it look like? [2p]When executing this arbitrage trade, investors buy bond B. What is the intuition? It isuseful to compare the yields of the two Treasury bonds. [4p]As arbitrageurs are buying bond B, the price of bond B increases to 98.51. GivenPA=$94.78 and pв=$98.51, is there still an arbitrage? [1p]Given pa=$94.78 and pв=$98.51, what is the one-year yield of a Treasury bond in thismarket? [2p]

(f) Given pA=94.78 and pB=98.51, what is the one-year yield of a Treasury bond in this market? To…

Answered: A fixed income arbitrage hedge fund…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Bond A is a 4-year bond with a 10% coupon rate and Bond B is a 2-year bond with a 20% coupon rate. Both bonds have a face value of £100, and all coupons are paid annually, starting in year 1. Consider a portfolio that consists of one unit of Bond A and one unit of Bond B. The yield curve is flat at ? = 5%. Explain how a fund can hedge its interest rate risk using 3-year zero-coupon bonds with a face value of £100.
Risks of investing in bonds A security with higher risk will have a higher expected return. A bond’s risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The curves on the following graph show the prices of two 10% annual coupon bonds at various interest rates. Q1. Based on the graph, which of the following statements is true? a. Neither bond has any interest rate risk. b. The 10-year bond has more interest rate risk. c. Both bonds have equal interest rate risk. d. The 1-year bond has more interest rate risk. Q2. Which type of bonds offer a higher yield? a. Noncallable bonds b. Callable bonds Q3. Answer the following question based on your understanding of interest rate risk and reinvestment risk. True or False: Assuming all else is equal, the shorter a bond’s maturity, the more its price will change in response to a given change in interest rates.…
Suppose that the prices of zero-coupon bonds with various maturities are given in the following table. The face value of each bond is $1,000. Maturity (Years) 1 2 3 4 5 Price $983.78 865.89 797.92 732.00 660.24 Required: a. Calculate the forward rate of interest for each year. b. How could you construct a 1-year forward loan beginning in year 3? c. How could you construct a 1-year forward loan beginning in year 4?
A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Suppose the bond issued by Logan Inc. has 5-year maturity with coupon of 12%. 4.1. If the yield to maturity is 10%, compute the bond value. Compute the modified duration of this bond. Use the modified duration to estimate the change in price if the interest rate decreases by 0.50%. 4.2. 4.3.
Two bonds A and B have the same credit rating, the same par value and the same coupon rate. Bond A has 30 years to maturity and bond B has five (5) years to maturity. Please demonstrate your understanding of interest rates risk by answering the following questions : Discuss which bond will trade at a higher price in the market Discuss what happens to the market price of each bond if the interest rates in the economy go up. Which bond would have a higher percentage price change if interest rates go up? Please substantiate your argument with numerical examples. As a bond investor, if you expect a slowdown in the economy over the next 12 months, what would be your investment strategy? note: all answers needed
Consider a $1,000-par-value Bond with the following characteristics: a current market price of $761, 12 years until maturity, and an 8% coupon rate. We want to determine the discount rate that sets the present value of the bond’s expected future cash-flow stream to the bond’s current market price. You are required to determine the discount rate that equates the present value of the bond?
Which of the following statements is CORRECT? a. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates, other things held constant. b. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline. c. You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline. d. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates. e. The time to maturity does not affect…
Spencer did research on the bond market and found the following default-free zero-coupon bonds: Bond Years to Maturity Yield to Maturity Par Value A 1 3.0% $1,000 B 2 4.0% $1,000 C 3 5.0% $1,000 D 4 6.0% $1,000 E 5 7.0% $1,000 Using implied rates, what will the price of Bond D be two years from now? $810.55 $831.60 $856.73 $910.28 $1025.03
Lantech investor is deciding between two bonds: Bond A pay $72 annual interest and has a market value of $925. It has 10 years to maturity. Bond B pays $62 annual interest and has a market value of $910. It has two years to maturity. Par value of the bonds is $1,000. A. What is the current yield on both bonds? B. Which bond should be chosen and why? C. A drawback of current yield is that is doesn't consider the total life of the bond. E.g. Yield to maturity on Bond A is 8.33 percent. What is the yield to maturity on Bond B? D. Is your answer changed from parts B and C based on which bond should be chosen?
The Expectations theory suggests that under certain conditions all bonds outstanding, especially Treasury bonds, must have identical total returns over a 1-year holding period, independently of their final maturity. suppose that today’s interest rate on a 2-year default free zero-coupon Treasury bond that pays $100 at maturity (0i0,2) is 6%. What is today’s price of such a bond (that is, what would you pay to purchase such a bond)?
First, it is known that two bonds have the same redemption value and coupon rate and are priced at the same yield rate. The first bond has a tenor of 4 years, while the second bond has a tenor of 10 years. The market yield rate then falls by 1% such that the prices of the first and second bonds change by D1% and D₂%, respectively, from their initial prices. Determine the relationship between D1 and D₂ Notes: |x| is the absolute value of x. a. D1 and D2 have negative signs and |D1|>|D2|.b. D1 and D2 have a positive sign and |D1|>|D2|.c. D1 and D2 have positive signs and |D1|<|D2|.d. D1 and D2 have different signs and |D1|>|D2|.e. D1 and D2 have different signs and |D1|<|D2|
a. Consider a hypothetical scenario where you have a default-free floating rate bond and a corporate floating rate bond with maturities of 5 years. The current default- free floating rate is 4% and the corporate floating rate is 6%. While the rates are quoted annually, both bonds pay coupons semi-annually. The face value of both bonds is $100. Describe step-by-step how you would set up the positions (long and short) to mimic the cash flows of a credit default swap. What would be the CDS rate? b. Assume the "loss given default” is $40 in the problem above. Suppose the loss given default changes and becomes $60. How would the CDS rate change given the increase in "loss given default." c. Suppose the probability of default before 5 years is 2% in the above problem. Now imagine that the probability of default falls to 1%. How would the CDS rate change?

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