Question

1. If the price of the 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 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

2. A yield curve derived from a series of yields-to-maturity on zero-coupon bonds is the:

A. A par curve.

B. A spot curve.

C. A forward curve.

D. None of the above.

3. Which of the following statement is FALSE about Yield-to-maturity? YTM is equal to annualized holding period return if:

A. You receive all the scheduled cash flow.

B. You hold it to maturity.

C. You can reinvest at the same rate.

D. You can reinvest at a higher rate than the initial YTM.

Answer 1

Answer:

1.The correct answer is option 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

It should not take us long to derive that we are talking about annual coupon rate of 20% and zero bonds with face value of $ 100.

1 year coupon bond cash flows:

In 6 months time: coupon = 20%/2 x 1,000 = $ 100 - this can be matched by selling 1 unit of 6 month zeroIn 1 years'time: coupon = 20%/2 x 1,000 = $ 100; principal redemption = 1,000; total 1,100; this can be matched by 11 units of 1 yero zero

hence, the correct answer is the option B)

2.Spot curve is related to provide the discounting of a single cash flow at the maturity and these will be taking the the series of yield to maturity on zero coupon bonds so these are known as spot curve.

Other forward curve and par curve are used for coupon bonds.

Correct answer will be option (B) spot curve

3.Option D is correct. You can reinvest at a rate higher than YTM.

For the YTM and Holding Period Return to be same, If reinvestment is done at a higher rate then the holding Period return will be more than the YTM.

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