Question

If the price of a 1-year coupon bond was $1030. How would you take advantage of the arbitrage opportunity?

A. Buy 1 unit of 1-yr coupon bond, sell 10 unit of the 6-mo zero and 110 unit of the 1-yr zero

B. Buy 1 unit of 1-yr coupon bond, sell 1 unit of the 6-mo zero and 11 unit of the 1-yr zero

C. Sell 1 unit of the 1-yr coupon bond, buy 10 unit of the 6-mo zero and 110 unit of the 1-yr zero

D. Both A and B are correct

Answer 1

Answer:

• The correct answer is Option B.

Expanation:

It ought not take us long to infer that we are discussing yearly coupon pace of 20% and zero bonds with face value of $ 100.

1 year coupon bond cash flows:

In a half year time:

Coupon = 20%/2 x 1,000 = 0.1*$ 1,000 = $ 100 - this can be coordinated by selling 1 unit of half year zero

In 1 year time:

Coupon = 20%/2 x 1,000 = 0.1*$ 1,000 = $ 100; principal redemtion = 1,000; total 1,100($ 1,000 +$ 100) ; this can be coordinated by 11 units of 1 year zero

subsequently, the right answer is the B(Buy 1 unit of 1-yr coupon bond, sell 1 unit of the 6-mo zero and 11 unit of the 1-yr zero).