Question

Given the following information:

Settlement date: 13 August 2001

Treasury bond maturity date: 25/11/2010

Treasury bond coupon rate: 6.25 percent, paid semiannually

Treasury bond quoted price: 110.20

Futures quoted price: 115.94

Futures expiry date: 28/09/2001

Repo rate: 4.9 percent

Assume that the bond has a $100 million face value, and futures contract has a $1 million

nominal amount.

a) What is the implied repo rate? Interpret your finding.

b) What is cash and carry arbitrage trade? Explain the process.

c) Is there a cash-and-carry arbitrage based on the information above?

d) What is the dollar amount of profit or loss?

Answer 1

a) Implied repo rate is the rate of return used to earn net profit from selling a future bond and simultaneusly re-buying it with same value in cash market through borrowed funds. It is a repurchase agreement, arranging to buy and sell subsequently. This is done to reduce the level of risk of value of bond if decreased before repayment time.

Formula for the calculation of the implied repo rate:

Here, invoice price =115.94

purchase price of bond = 110.20

daybase = 365days

days to delivery = 46 days

Therefore, (115.94/110.20-1)(365/46) = 6.88%

b) Cash and carry arbitrage trade: It is a stratergy used by the trader to generate profits using mispricing between underlying asset and derivative. In this, the trader opts for long position in commodity and at the same time take short positioning for financial derivative and sell it off.

c) No, cash and carry arbitrage trade staratergy is not used here above in this question.

d) The dollar amount of profit is $5.74