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Company A has a new project that will require an investment of $500,000 at t=3. You will fund this project in two ways. The company

Company A has a new project that will require an investment of $500,000 at t=3. You will fund this project in two ways. The company has a current project that will produce $100,000 one year from today. At t=1, the company will deposit the money from its current project for two years (it will buy a two-year bond worth $100,000). It will use the proceeds from this bond (which matures at t=3) to partially fund the new project. It will raise the remaining balance needed by issuing a one year bond at t=3. Your manager has asked you to hedge all interest rate risk. (interest rates for different maturities (1yr, 2, 3, 4, 5) are (1.0%, 2.8, 4.5, 5.5, 4.0) respectively.)

a. What is the cash flow at t=3 from the FRA associated with the two-year bond?

b. What must be the value of the one-year bond issued at t=3?

c. What is the cash flow at t=4 from the FRA associated with the one-year bond?

d. In total, what amount will the company need at t=4 in order to fulfill its obligations?

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