Fixed Inc

1. In the excel worksheet, we combined the 12% non-callable bond maturing in May 05 and the zero coupon STRIPS with the same maturity to get a synthetic bond with semiannual interest payments of $4.125 per $100 par value. The ask and bid prices of the synthetic bond are calculated to be $98.78 and $98.53.
Alternatively, we combined the non-callable bond maturing in 2000 and the STRIPS 00 to get a synthetic bond to match the callable bond if it was called at the first possible date. The ask and bid prices are $100.43 and $100.28.

2. A. Since the original bond is overpriced, we will buy 0.6875 units of 12 May 05 bond at $129.91 and 0.3125 units of May 05 STRIP at $30.31. We will sell 1 unit of 8¼ May 00-05 at $101.125, which give us of a profit = 101.123-(129.91*0.6875+30.31*0.3125)=2.3418.
Alternatively, if the bond was called at the first callable date, we will buy 0.9296 units of 8 7/8 May 00 @ $104.5and 0.0794 units of STRIPS 00 @ $46.66, and sell 1 unit of 8¼ May 00-05 at $101.125, which give us a profit = 101.125-(0.9296*104.5+0.0704*46.66)=0.6985
B. Arbitrage strategy: Buy 0.6875 units of 12 May 05 and 0.3125 units of May 05 and sell 1 unit of 8¼ May 00-05 if the bond was not called; Buy 0.9296 units of 8 7/8 May 00 and 0.0704 units of STRIPS 00 and sell 1 unit of 8¼ May 00-05 if the bond was called.