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Basic Question 6 of 7
A bond has an arbitrage-free value 95.36 and is trading at a price of 94.60. Would the dealer strip this issue and what would be the gain or loss?
B. No; loss would be .76.
C. Yes; gain would be .76.
A. Yes; gain would be 6.1%
B. No; loss would be .76.
C. Yes; gain would be .76.
User Contributed Comments 16
| User | Comment |
|---|---|
| chenyx | If the arbitrage-free value is greater,the dealer shoukd strip the issue. |
| MaiHuong | How to compute 0.76? (95.36-94.6)/94.6 = 0.8 |
| o123 | 95.36-94.6=0.76 the question didnt ask for the percentage gain/loss. |
| capitalpirate | what about if arbitrage-value less, wouldnt he still strip it? u make money irrespective, as long as it different, right??? |
| Bududeen | if the arbitrage value is less loss no striping occurs |
| mattg | Bududeen & chenyx: you are incorrect - if the arbitrage free value is LESS than the price, you SHOULD strip and sell the pieces because you can buy them relatively cheaply and sell them at a premium, thereby making a risk free profit. That is why the answer is C above |
| thekid | mattg: YOU ARE INcorrect! if arbitrage free value is LESS than price, then you would RECONSTITUTE the strips (meaning you would rather put the strips together and sell as a whole which will give you a higher price). |
| zkhan87 | and sell the bond at the spot to take advantage of the arb opp |
| zkhan87 | if arb free value is less than spot, sell the bond at spot and buy the zero strips |
| gulfa99 | i think the answer is B. As per the question the fair value of the bond is 95.36 but is trading lower at 94.60...if i strip the bond, meaning sell the bond and buy the strips i would lose money! can someone explain why i am wrong |
| gulfa99 | from another angle, i would buy the bond, and sell the strips for higher cash-flows to earn a profit..in this case c makes sense |
| 2014 | Price should be equal to free arbitrage value then only there is no opportunity to buy or short am i rite so both sides sell strips & buy strips is it depending upon opportunity |
| johntan1979 | I believe the answer should be B. In previous examples, current values are all higher (100) than arbitrage-free values. The whole idea of stripping is if arbitrage exists, and it exists only if the arbitrage-free value is lower than the current value. In that way, you make a risk-free profit by selling at spot. Answer should be B. Very sure about this. |
| johntan1979 | #@#$ sorry. Forget my previous comment. In the notes, the arbitrage-free price is higher ($930.67). Sell and gain $30.67 risk-free profit over current value ($900). So for this question, answer C is correct. It's very confusing but once you understand the concept, you know there's only one answer. |
| Shaan23 | You guys are making this complicated. It's just like in equities when we did the intrinsic value and market value questions. The IV(Arbitrage Value) > Market Price(price trading at) ---> so it is undervalued so BUY it ---> there is a gain. |
| khalifa92 | arbitrage value is like intrinsic value |
Your review questions and global ranking system were so helpful.
Lina
Learning Outcome Statements
explain what is meant by arbitrage-free valuation of a fixed-income instrument;
calculate the arbitrage-free value of an option-free, fixed-rate coupon bond;
CFA® 2025 Level II Curriculum, Volume 4, Module 27.