Suppose that you observe the following four bonds trading in the market. Bond Coupon Time-to-maturity Price A 5% 0.5 101.99 B 3% 1 101.49 C 4% 1.5…

Do you see any

potential problems? Why?

3. Suppose that you have a technology that allows you to store money for free (a “mat-

tress”) between years 1.5 and 2. That is, if you put $x under your mattress at t = 1.5,

you will still have $x at t = 2. Construct a long-short trading strategy using the four

bonds that earns you free money today.

Hint: Identify which bond you view as overpriced and start by shorting that bond. Then,

use the other bonds to net out the cash flows.