Reference no: EM133072527

Your fixed income arbitrage hedge fund has $100 in capital. Assume that you observe the following two U.S. Treasury bonds today (both bonds just paid their last coupon payment yesterday):

Bond Issue Date Maturity
Date Coupon
Rate Price
(Dirty) Yield-to-Maturity Modified Duration
A 6/15/00 6/15/30 4.50% 700 2.00% 6.5
B 6/15/10 6/15/30 2.50% 1,000 2.50% 7.5

[A] Briefly explain how you could take advantage of an existing arbitrage opportunity by buying 1 of the bonds and short selling 1 of the other bonds. (You will buy or sell exactly 1 of each bond.)

[B] If your broker charged you a 2% haircut on a repurchase agreement for your long position and re-quired 5% margin on your short position, how much cash would you have to invest to execute both trades?

[C] Is this trade eventually guaranteed to be profitable? What are the risks for your $100 fund?

[D] If the yields shifted higher, but the spread remained the same, would you expect to make a profit or a loss, or would you make $0 in net profit? Briefly explain. (No calculations required to answer this part)

[E] Briefly explain whether you believe that fixed income arbitrage is a high or low Beta strategy.