Use the data from Problem 18. Suppose that you want to construct a 2-year maturity forward loan
Question:
Use the data from Problem 18.
Suppose that you want to construct a 2-year maturity forward loan commencing in 3 years.
a. Suppose that you buy today one 3-year maturity zero-coupon bond. How many 5-year maturity zeros would you have to sell to make your initial cash flow equal to zero?
b. What are the cash flows on this strategy in each year?
c. What is the effective 2-year interest rate on the effective 3-year-ahead forward loan?
d. Confirm that the effective 2-year forward interest rate equals (1 + f4) × (1 + f5) − 1.
You therefore can interpret the 2-year loan rate as a 2-year forward rate for the last two years.
Alternatively, show that the effective 2-year forward rate equals
(1 + y5)5 ________
(1 + y3)3 − 1
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