The yield to maturity on one-year- maturity zero coupon bonds is 5% and the yield to maturity on...

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The yield to maturity on one-year- maturity zero coupon bonds is 5% and the yield to maturity on two-year-maturity zero coupon bonds is 6%. The yield to
 maturity on two-year-maturity coupon bonds with coupon rates of 12% (paid annually) is 5.8%. What arbitrage opportunity is available for an investment
 banking firm? What is the profit on the activity?

David · Accepted Answer

Coupon Rate: 12% 
Let the face value of bond be $1000. 
Two Options available are: 
Option I : Based on the yield to maturity of  zeros with one and two years of maturity after they 
are sold separately as zeros , it could be sold separately for: 
(120/ 1.05) + (1120/1.06
2
) = $ 1,111.

The yield to maturity on one-year- maturity zero coupon bonds is 5% and the yield to maturity on two-year-maturity zero coupon bonds is 6%. The yield to maturity on two-year-maturity coupon bonds with...

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