All amounts in this question are in denominations of millions Consider three 2 year bonds, A, B, and C, that mature on the same date (exactly 2 years from now i e t 2) and pay annual coupons at the same points in time All bonds have the same face value of $1000 Bond A has an annual coupon of 2 with a current price of $940 Bond B has an annual coupon of 8 with a current price of $1020 a) If Bond C has an annual coupon of 10 , what should be its current price that is consistent with no arbitrage Hint back out the DFs b) A pharmacy has just settled a lawsuit which calls for it to pay $100 in yr 1, and $2000 in year 2, starting in one year from now i e t 1 It currently has enough cash on hand to cover these payments Your objective is to invest this cash to protect Plaintiff Inc from interest rate risk by creating a synthetic position that perfectly replicates the scheduled payments Design this portfolio using bonds A and B synthetically What will be the cost of setting up this hedge

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Posted on Aug 22, 2024

All amounts in this question are in denominations of millions . Consider three 2-year bonds, A, B, and C, that mature on the same date

All amounts in this question are in denominations of millions

Consider three 2-year bonds, A, B, and C, that mature on the same date (exactly 2 years from now i.e. t=2) and pay annual coupons at the same points in time. All bonds have the same face value of $1000. Bond A has an annual coupon of 2% with a current price of $940. Bond B has an annual coupon of 8% with a current price of $1020.

a) If Bond C has an annual coupon of 10%, what should be its current price that is consistent with no-arbitrage? Hint: back out the DFs.
b) A pharmacy has just settled a lawsuit which calls for it to pay $100 in yr 1, and $2000 in year 2, starting in one year from now i.e. t=1. It currently has enough cash on hand to cover these payments. Your objective is to invest this cash to protect Plaintiff Inc. from interest rate risk by creating a synthetic position that perfectly replicates the scheduled payments. Design this portfolio using bonds A and B synthetically. What will be the cost of setting up this hedge?