A fixed income arbitrage hedge fund focuses on Treasury bond trading. Bond A is a ten-year Treasury bond (Notes) which was issued eight years ago in a low interest environment. Bond B 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, face value and prices. t=1 t=2 Price at t=0 Bond A: $2 $2+$100 $94.78 Bond B: $4 $4+$100 $96.43 (a) (b) (c) (d) (e) (f) Is there an arbitrage? [2p] 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 of an investment bank to execute a trade of the two bonds such that he makes $100 million 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 is useful 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. Given PA=$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 this market? [2p]
A fixed income arbitrage hedge fund focuses on Treasury bond trading. Bond A is a ten-year Treasury bond (Notes) which was issued eight years ago in a low interest environment. Bond B 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, face value and prices. t=1 t=2 Price at t=0 Bond A: $2 $2+$100 $94.78 Bond B: $4 $4+$100 $96.43 (a) (b) (c) (d) (e) (f) Is there an arbitrage? [2p] 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 of an investment bank to execute a trade of the two bonds such that he makes $100 million 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 is useful 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. Given PA=$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 this market? [2p]
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
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![A fixed income arbitrage hedge fund focuses on Treasury bond trading. Bond A is a ten-year
Treasury bond (Notes) which was issued eight years ago in a low interest environment. Bond
B 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, face
value and prices.
t=1
t=2
Price at t=0
Bond A:
$2 $2+$100
$94.78
Bond B:
$4
$4+$100
$96.43
(a)
(b)
(c)
(d)
(e)
(f)
Is there an arbitrage? [2p]
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 of
an investment bank to execute a trade of the two bonds such that he makes $100
million 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 is
useful 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. Given
PA=$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 this
market? [2p]](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F3816d8fb-3787-4dd6-8c21-26d7d3ffb1d4%2Ffae8ca33-c847-4551-a5bc-f8e0e9bd2151%2F4r45jyl_processed.jpeg&w=3840&q=75)
Transcribed Image Text:A fixed income arbitrage hedge fund focuses on Treasury bond trading. Bond A is a ten-year
Treasury bond (Notes) which was issued eight years ago in a low interest environment. Bond
B 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, face
value and prices.
t=1
t=2
Price at t=0
Bond A:
$2 $2+$100
$94.78
Bond B:
$4
$4+$100
$96.43
(a)
(b)
(c)
(d)
(e)
(f)
Is there an arbitrage? [2p]
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 of
an investment bank to execute a trade of the two bonds such that he makes $100
million 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 is
useful 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. Given
PA=$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 this
market? [2p]
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