Look back at our example in Section 24.4 of the short-, medium-, and long-term bonds. Remember that we said that the prices must stand in a particular relationship or there would be an arbitrage opportunity. This means that we can take advantage of the risk answer the following questions:
(a) Suppose that the price of the short bond is 98 and the price of the medium is 83. What is the price of the long bond?
(b) What are the possible future prices of these three bonds at the end of three months if rates rise and if they fall?
(c) What would be the expected return over the three months on each bond?
(d) What is the probability of an interest rate rise?
(e) Show that the expected return on each bond is equal.
(a) Suppose that the price of the short bond is 98 and the price of the medium is 83. What is the price of the long bond?
(b) What are the possible future prices of these three bonds at the end of three months if rates rise and if they fall?
(c) What would be the expected return over the three months on each bond?
(d) What is the probability of an interest rate rise?
(e) Show that the expected return on each bond is equal.
