Answer: buy Bond C and sell Bond B.

## Explanation The correct strategy is to **buy Bond C and sell Bond B**. **Scenario Analysis:** - **Yield curve flattening due to decrease in long-term rates** means long-term rates are falling while short-term rates remain relatively stable - When long-term rates decrease, bond prices increase **Bond Characteristics:** - **Bond A (Putable):** Benefits from falling rates (price increases) but has embedded put option that caps upside potential - **Bond B (Callable):** Has limited upside potential because issuer can call the bond when rates fall - **Bond C (Straight):** Has the most upside potential when rates fall, with no embedded options limiting price appreciation **Strategy Rationale:** - Buying Bond C (straight bond) provides maximum exposure to falling long-term rates - Selling Bond B (callable bond) benefits because callable bonds have limited upside when rates fall (call risk) - This strategy creates a spread trade that profits from the relative price movements Buying Bond A and selling Bond C would not be optimal because both bonds benefit from falling rates, but the straight bond has more upside potential.

Author: LeetQuiz Editorial Team