Solutions to in-calss exercises_Chapter 5

Solutions to in-calss exercises_Chapter 5 - sell short at...

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1 Solution to in-class exercise 1  1) For a Treasury bond, the number of  days between the settlement date and the  next coupon payment date is  108 days and the number of days in the coupon  period is  184 days . So the  w  periods  =  108 days / 184 days = 0.586957   
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2 Solution to in-class exercise 1  2) For an agency bond, the number of  days between the settlement date and the  next coupon payment date is  105 days and the number of days in the coupon  period is  180 days . So the  w  periods  =  105 days / 180 days = 0.583333
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3 Solution to in-class exercise 2 Traditional approach : 038 . 112 $ 0185 . 1 105 $ 0185 . 1 5 $ 0185 . 1 5 $ 0185 . 1 5 $ 4 3 2 1 = + + + Arbitrage-free approach : 015 . 112 $ 0185 . 1 105 $ 019 . 1 5 $ 0195 . 1 5 $ 02 . 1 5 $ 4 3 2 1 = + + +
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4 Solution to in-class exercise 2  A dealer can buy the Treasury strips for each 6- month period at the spot rates in the table and 
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Unformatted text preview: sell short at $112.038 the 10% 2-year Treasury bond whose cash flows are being replicated (this procedure is called reconstitution , which is the opposite of stripping a coupon bond), and realize an arbitrage profit of $0.023 (= $112.038 - $112.015) The cash flows from the package of Treasury strips purchased are used to make the payments for the Treasury coupon bond sold short 5 Solution to in-class exercise 2 Other dealers will follow suit and sell short this bond. As a result, and the price of this bond will decrease to $112.015. At this price, the arbitrage opportunity just described will no longer exist...
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This note was uploaded on 05/01/2011 for the course ADMS 4504 taught by Professor Lee during the Fall '08 term at York University.

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Solutions to in-calss exercises_Chapter 5 - sell short at...

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