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Answer: USD101.29
C is correct. To determine the price (F3) of the 6% coupon bond by replication, where F1 and F2 are the weight factors in the replicating portfolio for the zero-coupon bond and the 7% coupon bond, respectively, corresponding to the proportions of the zero-coupon bond and the 7% coupon bond to be held, and given a 1-year horizon: The three equations below express the requirement that the cash flows of the replicating portfolio, on each cash flow date (t, in years), be equal to the cash flow of the 6% coupon bond: Time (t=0): 97*F1 + 102*F2 = F3 Equation (1) Time (t=0.5): 0*F1 + 3.5*F2 = 3.5 Equation (2) Time (t=1.0): 100*F1 + 103.5*F2 = 103 Equation (3) From Equation (2), F2 = 3/3.5 = 0.8571 Substituting the value of F2 in Equation (3): 100*F1 + 103.5*0.8571 = 103, giving, F1 = 0.1429 Plugging the values of F1 and F2 in Equation (1), we determine F3= 97*0.1429 +102*0.8571 =101.2855
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A financial analyst is working on detecting potential arbitrage opportunities in the Treasury bond market. This involves comparing the cash flows from certain bonds with those from a combination of other bonds. Currently, there are two specific bonds under consideration:
Given this information, what would be the calculated price for a 1-year Treasury bond with a 6% coupon that also pays interest semi-annually, using a replication strategy?
A
USD 97.71
B
USD101.04
C
USD101.29
D
USD 102.86