Deck 1: An Introduction to Fixed Income Markets

Question 1

What are the gains from trade of entering into a swap for these two ?rms?

Answer 1

Gains from trade are 1%.

Question 2

What are the gains from trade of entering into a swap for these two ?rms?

Answer 2

Gains from trade are zero.

Question 3

Is the following an arbitrage opportunity? A security that cost zero and might pay a dollar in the future, but pays zero otherwise.

Answer 3

This is an arbitrage opportunity because I get for free the chance of getting a dollar in the future.

Question 4

Intuitively, is the Federal Funds rate generally higher, lower or the same as LIBOR? Why?

Question 5

What steps would you follow in order to take advantage of the following arbitrage opportunity (if there is one)? Security A costs $100 and pays $120 in 3 years. Security B costs $100 and pays $110 in one year. Your friend tells you that he would like you to lend him $110 in a year and that he would give $130 the following year. Finally you know that in two years, with $130, you can invest in a security that will pay you either $140 or $121 (with equal probability) after a year. 2

Question 6

What are the gains from trade of entering into a swap for these two ?rms?

Question 7

What steps would you follow in order to take advantage of the following arbitrage opportunity (if there is one)? Security A costs $3 and pays $5 in 2 years, while security B costs $3 and pays $4 in 2 years.

Question 8

Is the following an arbitrage opportunity? A free car that if I repair well, I won't have to spend money on gasoline or maintenance costs (i.e. repairs) ever.

Question 9

What are the steps to take a short position on a given U.S. security via the repo market?

Question 10

You are told that there is an ample supply for the bond mentioned in question 13. Does this affect your previous answer?

Question 11

Is the following an arbitrage opportunity? A gift that makes me feel good just by having it.

Question 12

What are the steps to take a long position on a given U.S. security via the repo market?

Question 13

Is the following an arbitrage opportunity? A bond that cost nothing but will payoff zero with certainty in the future.

Question 14

Intuitively, is LIBOR generally higher, lower or the same as the repo rate? Why?

Question 15

You find a bond that has a repo rate substantially lower than the GCR. Is this, for certain, an arbitrage opportunity?

Question 16

Is the following an arbitrage opportunity? Suppose you are in the desert and are given a bag of ice with a penny inside. Assume that the ice will melt instantly and the cost of disposing of the bag is zero.

Question 17

What steps would you follow in order to take advantage of the following arbitrage opportunity (if there is one)? Security A costs $100 and pays $110 in 2 years. Security B costs $100 and pays $109 in one year. You know that in a year with $109 you can invest in a security that pays $120 or $109 (with equal probability) the following year.