Reference no: EM133115264

Today you observe the following:

1. Six-month Treasury bills that pay a yield of 2.00% per 6 months. 2. Sixteen-year Treasury bonds that pay 4% interest-coupon per year. The current price of the bonds is $101 per $100 face value. 3. Futures contracts, with 6 months to delivery, on the Treasury bonds above. The current futures price is $102 per $100 face value.

A. You are the senior risk manager at the wealth management company, Rising Stars. The company owners, Lillian, and Tsu-Chang, wish to invest money in a riskless strategy for 6 months. Construct two riskless investment strategies for 6 months using the securities above. Which strategy is preferable?

B. You can borrow and invest at the same riskless interest rate of 2%, over 6 months. Based on the data above, calculate the cash and carry value until the Treasury bonds futures delivery day (remember to subtract the interest-coupon income, which is based on the face
value).

C. Based on the data above, is there an arbitrage opportunity for an investor with zero initial investment? If yes, design the arbitrage and calculate the profits.

D. Suppose that the actual futures price is $101.02. Recalculate the returns on the two riskless 6-month investment strategies above. Which strategy is preferable?

E. Looking at your answers to (A) through (D) above, can the relation between the futures price and the cash and carry value explain the relation between the returns on the synthetic and actual riskless 6-month investment strategies that you calculated in (A) and (D)?