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Question 4: (5+5 pts) All amounts in this question are in denominations of millions. Consider three 2-year bonds, A, B, and C, that mature on
Question 4: (5+5 pts) 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 $100 as usual. Bond A has an annual coupon of 4% with current price of $91. Bond B has an annual coupon of 8% with current price of $98. a) If Bond C has an annual coupon of 10%, what should be its current price that is consistent with no arbitrage? b) A pharmaco. has just settled a law suit which calls for it to pay $1000 per year for 1 year, 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 position using bonds A and B. What will be the cost of setting up this hedge
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