Let's take a look at a 5% corporate bond with five years until maturity and the usual semi-annual coupon payments. The bond currently yields 3% each year (or 1.5% every other year, if compounding effects are ignored to keep things simple). The bond costs $109.22, which is also its present value.
On an Excel spreadsheet, the PV function can be used to quickly compute the present value, as
=PV(1.5%,10,-2.50,-100). Alternatively, enter i=1.5%, n=10, PMT=-2.5, FV=-100 into a financial calculator.
After that, an arbitrager would sell the bond to Trader Tom for $105, while concurrently purchasing it elsewhere for $104.49, earning $0.51 in risk-free profit for every $100 of principle. The chance for an arbitrage would vanish shortly either because Trader Tom would realise his mistake and re-price the bond yield at 4%.
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