Question
Suppose you are an investor in bonds. Consider a corporate bond with a $100 par value, a 5% coupon paid semi-annual coupon, and five years
Suppose you are an investor in bonds. Consider a corporate bond with a $100 par value, a 5% coupon paid semi-annual coupon, and five years to maturity. The bond presently yields 3% annually. Suppose that interest rates rise shortly, and the yield on comparable bonds is now 4%. After observing this change, you call your broker Jane for a quote on the bond. Jane shows that the bond price is $105. You quickly realize that there is an arbitrage opportunity in this market. Assuming away any transaction cost and tax, you can simultaneously buy and sell the bond and pocket a risk-free profit per $100 of par that is closest to (Hint: you would need to first calculate what the bond price should actually be):
A. | $1.00 | |
B. | $0.51 | |
C. | $0.422 | |
D. | None of the above |
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