Case Study: Arbitrage in the Government Bond Market? Directions: The case write-up should be no more than five pages, double-spaced and answer the following four questions. Case Questions: 1) Create the two synthetic bonds described in the case. How should the price of these synthetics relate to the callable bonds? Why? On January 7, 1991, how much would it cost to create the synthetic using the 05s? The 00s? 2) On January 7, 1991, how could Thompson exploit this apparent anomaly for investors who own the 8.25 May 00-05? What can investors not owning the callable bond do to profit? 3) What might underlie the odd relative prices of the bonds Thompson is considering? 4) Why should the treasury issue callable debt? When should they exercise their right to call or redeem the bonds? Why would corporations issue callable debt? Why should investors want to buy callable debt?
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