Your fixed income arbitrage hedge fund has $100 in capital. Assume that you observe the following two U.S. Treasury bonds today (both bonds just paid their last coupon payment yesterday):

Bond	Issue Date	Maturity Date	Coupon Rate	Price (Dirty)	Yield-to-Maturity	Modified Duration
1	6/15/10	6/15/30	3.50%	800	6.00%	7.5
2	6/15/00	6/15/30	6.50%	1,000	6.50%	8.5

A] Briefly explain how you could take advantage of an existing arbitrage opportunity by buying 1 of the bonds and short selling 1 of the other bonds. (You will buy or sell exactly 1 of each bond.)

B] If your broker charged you a 3% haircut on a repurchase agreement for your long position and required 2% margin on your short position, how much cash would you have to invest to execute both trades?

C] If the yield on the 6.5% coupon bond decreased to the 6% yield on the 3.5% coupon bond, it would be worth $1,050; If the yield on the 6.5% coupon bond increased to 7%, it would be worth $950. Assume that the yield on the 3.5% coupon bond does not change.

What would your profit and rate of return be if the yield on the 6.5% coupon bond rose to 7%? How much more cash would you have to provide to the broker?

D] Is this trade eventually guaranteed to be profitable? What are the risks for your $100 fund?

E] If the yields shifted lower, but the spread remained the same, would you expect to make a profit or a loss, or would you make $0 in net profit? Briefly explain. (No calculations required to answer this part)