Question
Following is the term structure of the risk-free rate: Term (years) Interest rate (per year) 1 4.0% 2 4.5% 3 5.0% In the market, a
Following is the term structure of the risk-free rate:
Term (years) | Interest rate (per year) |
1 | 4.0% |
2 | 4.5% |
3 | 5.0% |
In the market, a bond that will pay $100 in year 3 currently sells for $80. An investor realizes that this market price is different from the present value of the bond. Recognizing the price deviation, the investor wants to make an arbitrage (risk-free and immediate profits requiring zero investment). Which of the following strategies results in an arbitrage?
Group of answer choices
Buy the bond + Borrow money with a promise to pay $100 in year 3
Buy the bond + Lend money and receive $100 in year 3
Sell the bond + Lend money and receive $100 in year 3
Given the prices, arbitrage does not exist.
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