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We consider two bonds that generate risk-free cash flows over the next two years and trade at market prices below. Cash flow ($) Security Price
We consider two bonds that generate risk-free cash flows over the next two years and trade at market prices below. Cash flow ($) Security Price today ($) in one year in two years Bond 1 94 100 0 Bond 2 85 0 100 Suppose a security with risk-free cash flows of $50 in one year and $100 in two years is currently trading for $130. Please explain why this is an arbitrage opportunity. How could you exploit this arbitrage opportunity? What would your arbitrage profit be?
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