# Bond arbitrage Question

Can sombody explain this… An investor gathers the following information about three U.S. Treasury annual coupon bonds: Bond #1 Bond #2 Bond #3 Maturity 2-year 1-year 2-year Price \$10,000 \$374.62 \$9,560 Coupon 4% 0% 0% Par Value \$10,000 \$400 \$10,400 Given the above information, how can the investor generate an arbitrage profit? A) Purchase bond #1 while selling bonds #2 and #3. B) No arbitrage profit exists. C) Purchase bonds #1 and #3 while selling bond #2. D) Purchase bonds #2 and #3 while selling bond #1. Answer is D

2# and 3# generate together same cashflows like 1# but 2# and 3# are in sum cheaper (374+9560) than 1# (10000) --> buy the cheap 2,3 and sell expensive 1

since all 3 are U.S. Treasury bonds; they should have same yield. bond 1 yield = 4% bond 2 = 6.77 bond 3 = 4.3 so buy 2 and 3 and sell 1

This seems convincing Thanks !!!

rahulv Wrote: ------------------------------------------------------- > since all 3 are U.S. Treasury bonds; they should > have same yield. > bond 1 yield = 4% > bond 2 = 6.77 > bond 3 = 4.3 > > so buy 2 and 3 and sell 1 Not really. Each maturity, can have it’s own yield without leading to arbitrage.