Question
Use the following information about default-risk-free zero-coupon bonds to answer the question below. Maturity(years) 1 2 3 4 5 Zero rate 5.00% 5.50% 6.00% 6.25%
Use the following information about default-risk-free zero-coupon bonds to answer the question below.
Maturity(years) | 1 | 2 | 3 | 4 | 5 |
Zero rate | 5.00% | 5.50% | 6.00% | 6.25% | 6.40% |
Suppose that a default-risk-free bond (with a face value (FV) of $1000 and 2 years to maturity) paying 5% coupons annually is currently trading at $1000.
Assuming there are no transaction costs and no taxes, what arbitrage opportunity is available?
A.Short sell a 1-year zero coupon bond with a FV of $50 and a 2-year zero coupon bond with a FV of $1050; buy the coupon bond with a FV of $1000.
B.Short sell a 2-year zero coupon bond with a FV of $1050; buy the coupon bond with a FV of $1000.
C.Buy a 2-year zero coupon bond with a FV of $1050; Short sell the coupon bond with a FV of $1000.
D.Buy a 1-year zero coupon bond with a FV of $50 and a 2-year zero coupon bond with a FV of $1050; Short sell the coupon bond with a FV of $1000.
E.No arbitrage opportunity exists.
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