Question
Use the following information to answer the remaining questions. Suppose you observe the following securities. Assume that all of them are priced correctly based on
Use the following information to answer the remaining questions.
Suppose you observe the following securities. Assume that all of them are priced correctly based on the appropriate spot rates.
- 1-year STRIP with a par value of $100 and a price of $97 (assume annual compounding)
- 2-year STRIP with a par value of $100 and a price of $91 (assume annual compounding)
- Treasury bond priced at par with 3 years left to maturity, a 5% coupon, and a $1000 par value (assume coupons are paid annually)
- Treasury bond priced at par with 4 years left to maturity, a 6% coupon, and a $1000 par value (assume coupons are paid annually)
Suppose you observe a 3-year Treasury bond with a 2% coupon (paid annually) and a $1,000 par value. What is the arbitrage-free price of this bond?
Suppose that the bond in question #7 has a yield-to-maturity of 5.50%. If you were to exploit this mispricing opportunity, what would your arbitrage profit be?
Assume that you can invest any amount in STRIPS and that 1-4-year STRIPS are correctly priced based on the spot rates that you have calculated. In order to benefit from the arbitrage opportunity in question #8, how much should you invest in a 1-year STRIP?
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