Question: A bond promises a risk-free payment of $1000 in one year. The risk-free rate of interest is 2.19%.
a) What is the price of the bond?
FV=$1,000 and r=2.09%=0.0219
Price of the bond = FV/(1+r)^n = $1000/1.0219 = $978.57
b) If the price of the bond is actually $950, what is the arbitrage strategy? Illustrate all cash flows today and one year from today.
c) If the price of the bond is actually $1000, what is the arbitrage strategy? Illustrate all cash flows today and one year from today.