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Assignment 3 - ActSc 371 Assignment#3 Posted November 2...

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ActSc 371: Assignment #3 Posted: November 2, 2005 Due: In class, November 11, 2005 (no electronic submission) Late Assignments Will Not Be Accepted Question 1 You observe the following prices for zero-coupon bonds (each has a face value of $100). Maturity Price 1 Year 92.5926 2 Years 84.1680 3 Years 75.1315 (a) What are the one, two and three-year spot rates? (b) What are the one-year forward rates over the second and third years? (c) What should the price of a three-year bond with a 10% annual coupon ($1000 face value) be? (d) Suppose the market price of a three-year bond with a 10% annual coupon ($1000 face value) was actually $1020.00. If this price disagrees with the price you found in (c), describe a strategy which would allow you to profit from this mispricing. Your strategy should put money in your pocket today and entail net cash flows of zero in future years. You should: State which bonds (and how many of each) you would purchase. State which bonds (and how many of each) you would sell short. Show all cash flows associated with your strategy.
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