Your fixed income arbitrage he

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

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.)

– If your broker charged you a 2% haircut on a repurchase agreement for your long position and required 5% margin on your short position, how much cash would you have to invest to execute both trades?

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

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.

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