Fixed Income Arbitrage is to find mispricing of coupon bonds through the system of linear equations...

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Fixed Income Arbitrage is to find mispricing of coupon bondsthrough the system of linear equations where # of equations > #of unknowns. Suppose there are only three treasury coupon bonds onthe market today:
Bond A: 2-year 2% treasury coupon bond, trading today at price$937.
Bond B: 2-year 3% treasury coupon bond, trading today at price$970.
Bond C: 2-year 4% treasury coupon bond, trading today at price$974.
Let ??0,1 and ??0,2 be the two unknowns, where ??0,1 denotes theprice today of a 1-year STRIPS, and ??0,2 the price today of a2-year STRIPS. Face value of STRIPS is $1. Questions:
1) Since each coupon bond is essentially a portfolio of STRIPS,write the 3-equation 2-unknown system.
2) If market price of STRIPS are: ??0,1 = 0.95 and ??0,2 = 0.9,plug into the 3- equation 2- unknown system, is there arbitrageopportunities in any of the coupon bonds, in which one(s)?

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A coupon paying bond can be expressed as a combination of STRIPS of different maturity Say for example a 2 year 2 coupon bond will pay 2 x Par value 2 x 1000 20 as first coupon at t 1 this is See Answer

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Fixed Income Arbitrage is to find mispricing of coupon bondsthrough the system of linear equations where # of equations > #of unknowns. Suppose there are only three treasury coupon bonds onthe market today:Bond A: 2-year 2% treasury coupon bond, trading today at price$937.Bond B: 2-year 3% treasury coupon bond, trading today at price$970.Bond C: 2-year 4% treasury coupon bond, trading today at price$974.Let ??0,1 and ??0,2 be the two unknowns, where ??0,1 denotes theprice today of a 1-year STRIPS, and ??0,2 the price today of a2-year STRIPS. Face value of STRIPS is $1. Questions:1) Since each coupon bond is essentially a portfolio of STRIPS,write the 3-equation 2-unknown system.2) If market price of STRIPS are: ??0,1 = 0.95 and ??0,2 = 0.9,plug into the 3- equation 2- unknown system, is there arbitrageopportunities in any of the coupon bonds, in which one(s)?