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Problem Set 2: Suppose that bond ABC is the underlying asset for a futures contract with settlement six months from now. You know the following about bond ABC and the futures contract:\r\n

(1) In the cash market ABC is selling for $80 (par value is $100).\r\n

(2) ABC pays $8 in coupon interest per year in two semi-annual payments of $4, and the next semi-annual payment is due exactly six months from now.\r\n

(3) The current six-month interest rate at which funds can be loaned or borrowed is 6%.\r\n


 2A: What is the theoretical futures price? (10 Points)\r\n


 2B: What action would you take if the futures price is $83 or $76? (5 Points)

2C: Suppose that bond ABC pays interest quarterly instead of semiannually. If you know that you can reinvest any funds you receive three months from now at 1% for three months, what would the theoretical futures price for six-month settlement be? (10 Points)\r\n

 2D: Suppose that the borrowing rate and lending rate are not equal. Instead, suppose that the current six-month borrowing rate is 8% and the six-month lending rate is 6%. What is the boundary for the theoretical futures price? (10 Points)