The following data provides the current market price, theoretical value and transaction costs for trading a treasury bond. Assume that the trader already owns this bond, and has sufficient trading limit to buy more, if needed. Based on this data, determine the correct trading action to undertake: Market price: $97.80 Theoretical price: $97.85 Brokerage/contract:$0.02 Select one: O a. Do nothing, due to positive impact of brokerage costs • b. Buy more bonds O C. Do nothing, due to adverse impact of brokerage costs • d. Sell existing bond holding
Question
The following data provides the current market price, theoretical value and transaction costs for trading a treasury bond. Assume that the trader already owns this bond, and has sufficient trading limit to buy more, if needed. Based on this data, determine the correct trading action to undertake: Market price: 97.85 Brokerage/contract:$0.02 Select one: O a. Do nothing, due to positive impact of brokerage costs • b. Buy more bonds O C. Do nothing, due to adverse impact of brokerage costs • d. Sell existing bond holding
Solution
The correct trading action to undertake based on the given data would be option C: Do nothing, due to adverse impact of brokerage costs.
Here's why:
The theoretical price of the bond is 97.80. This suggests that the bond is slightly undervalued in the market.
However, the brokerage cost per contract is $0.02. This means that if the trader buys more bonds, they would have to pay this additional cost, which would increase the total cost of buying the bond.
Given that the difference between the theoretical price and the market price is very small (only $0.05), the brokerage cost would eat into any potential profits from buying the bond at a lower price and selling it at a higher price.
Therefore, the most sensible action would be to do nothing due to the adverse impact of brokerage costs.
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