Question
Assume you can buy and sell zero coupon bonds ( face value $1000 ) of any maturity and that all bonds are trading at their
Assume you can buy and sell zero coupon bonds ( face value $1000 ) of any maturity and that all bonds are trading at their no-abitrage price implied by the term structure of r1 = 5% , r2 = 6.03% and r3 = 8.19% . An investor expects to receive a cash inflow of $5 million in one year's time, which she then plans to lend out immediately. The term of the loan will be two years, with fixed coupon interest paid to the investor at the end of each year, along with the repayment of the entire principal amount at the maturity of the loan. Explain how the investor could arrange this loan today and " lock in " the interest rate on the loan, stating exactly how many units of the required bonds need to be long/short and the resultant cash flows. what should the interest rate on this loan be?
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