Consider a 2-year coupon bond C with FV = $100, coupon rate = 25%, and price = $138. Is Bond C underpriced/overpriced relative to Bonds A and B? What is the potential arbitrage trading strategy?

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
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There are two zero-coupon bonds below:
Coupon Term to
rate
maturity
0%
1 year
10%
2 years
Bond
A
B
FV
$100
$100
Price
$95.24
$107.42
Consider a 2-year coupon bond C with FV = $100, coupon rate=25%, and price = $ 138.
Is Bond C underpriced/overpriced relative to Bonds A and B?
What is the potential arbitrage trading strategy?
O a. Overpriced; Long 3/22 unit of A; Long 25/22 unit of B; Short 1 unit of C
O b. Underpriced; Long 3/22 unit of A; Long 25/22 unit of B; Short 1 unit of C
O c. Overpriced; Long 3 unit of A; Long 25 unit of B; Short 1 unit of C
O d. Underpriced; Long 3 unit of A; Long 25 unit of B; Short 1 unit of C
Transcribed Image Text:There are two zero-coupon bonds below: Coupon Term to rate maturity 0% 1 year 10% 2 years Bond A B FV $100 $100 Price $95.24 $107.42 Consider a 2-year coupon bond C with FV = $100, coupon rate=25%, and price = $ 138. Is Bond C underpriced/overpriced relative to Bonds A and B? What is the potential arbitrage trading strategy? O a. Overpriced; Long 3/22 unit of A; Long 25/22 unit of B; Short 1 unit of C O b. Underpriced; Long 3/22 unit of A; Long 25/22 unit of B; Short 1 unit of C O c. Overpriced; Long 3 unit of A; Long 25 unit of B; Short 1 unit of C O d. Underpriced; Long 3 unit of A; Long 25 unit of B; Short 1 unit of C
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