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Question 3 A 7% annual coupon bond (face value $1,000), with three years left till maturity is selling for $986.90. Zero-coupon bonds of 1, 2, 3 years maturity (all with face value of $1,000) sell for $950, $900, $820, respectively. Is this coupon bond properly priced? If not, show an arbitrage transaction to profit $2000 (today) from the mispricing.

Question

 

 Question 3 

A 7% annual coupon bond (face value $1,000), with three years left till maturity is selling for $986.90. Zero-coupon bonds of 1, 2, 3 years maturity (all with face value of $1,000) sell for $950, $900, $820, respectively. Is this coupon bond properly priced? If not, show an arbitrage transaction to profit $2000 (today) from the mispricing.

check_circleAnswer
Step 1

Identity whether the coupon properly priced and determines the arbitrage transaction to profit of $2,000 today from the mispricing if the bond is not priced properly

Calculate the yield to maturity for both coupon bonds and zero coupon bonds:

Zero coupon bonds:

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Step 2

Excel workings:

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Step 3

Coupon bonds:

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