Suppose an investor would like to buy 200 Treasury notes. Theinvestor wants notes with an annual coupon rate of 7%, a 3-yearmaturity, and semi-annual coupon payments.
a. (5 pts) If there were no such Treasury note available,propose a portfolio for this investor (using only Zeroes withmaturities up to 3 years) that replicates the cash flows frominvesting in the Treasury notes above.
b. (5 pts) Assuming the yield curve is flat at 4.0% for bondswith maturities of up to 3 years, calculate the prices of theZeroes in your portfolio from part (a). Using these prices, computethe no-arbitrage price of a Treasury note.
c. (5 pts) Now suppose there is a 3-year, 7% coupon rateTreasury note available that has a YTM of 4.5%. Would the investorabove prefer to buy 200 Treasury notes or the portfolio of Zeroesidentified in part (a)?
d. (5 pts) Find a costless and riskless trading strategy thatmakes an instantaneous profit by buying or selling the Treasurynote and the portfolio of zeroes.
e. (5 pts) If this costless strategy required that you put up50% collateral for the short sales, would you be willing to use allof your available capital for collateral in this strategy?
