Explanation:
This calculation factors in the terminal cash flow for the bond seeking replication. In this case, that is $103. It makes sense that you would purchase less of the bond with a higher coupon rate.
(Book 4, Module 55.2, LO 55.e)
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Question 79
A fixed-income manager owns a three-year bond that is overpriced. It makes semiannual payments with a 6% coupon. The manager is planning to compute a replicating portfolio to exploit the arbitrage opportunity. One of the bonds that he plans to use to create a replicating portfolio is also a three-year bond, but it has an 8% coupon. This bond also has a present value of $104.56 and a face value of $100. What percent of par should the manager allocate to this bond using a replication approach?
A
98.72.
B
99.04.
C
101.76.
D
101.88.
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