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The yield to maturity (YTM) on 1-year zero-coupon bonds is 7% and the YTM on 2-year...

The yield to maturity (YTM) on 1-year zero-coupon bonds is 7% and the YTM on 2-year zeros is 8%. The yield to maturity on 2-year-maturity coupon bonds with coupon rates of 11% (paid annually) is 7.7%.

a. What arbitrage opportunity is available for an investment banking firm?

The arbitrage strategy is to buy zeros with face values of $____ and $____ , and respective maturities of one year and two years.

b. What is the profit on the activity?

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Expert Solution

The arbitrage strategy is to buy zeros with face value $110 for one year maturity so that it can be used for paying coupon on 2 year maturity coupon bond sold and buy zero coupon bond with face value $1110 so that it can be used to pay coupon and maturity value on 2 year coupon bond which is sold,a by adopting to this strategy we can earn profit of $ 4.64 ($1059.09-$1054.45) on selling each 2 year maturity coupon bond and simultaneously buying zeros with face values of $110 and $1110 with respective maturities of one year and two year.

jeff jeffy answered 1 year ago
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