Question
The following table shows the maturity, coupon rate and current market price for each of three government bonds, immediately after coupon payments. They have annual
The following table shows the maturity, coupon rate and current market price for each of three government bonds, immediately after coupon payments. They have annual coupon payments and a face value of $100. Answer the questions below. [Note: Be sure to show the calculation process explicitly. Express the interest rates in %, using annual compounding. In answering (1) and (2), round the final answers to the third decimal place.] Time to Maturity Coupon Rate Price Bond A 1 year 0% 95.5 Bond B 2 years 5% 100.0 Bond C 2 years 0% P (1) Given the prices of bond A and bond B, what should be the price P of bond C if there is to be no arbitrage opportunity? (2) Calculate the 1-year and 2-year spot rates. Then, calculate the 1-year (forward) rate, 1 year forward. (3) Suppose the actual market price of Bond C is less than the theoretical price (calculated in (1)) by $1. Describe how you would construct an arbitrage portfolio to profit from the deviation, specifying the amount of each bond in the portfolio. (4) Suppose the annualized yield volatility (standard deviation) for bond B is 60bp. What is the annualized price volatility (%) of bond B?
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