Emily is planning to sell a forward contract on 180-day bank bills, to be delivered at the end of 90 days, with a face value of $100 000. The current spot rate for 90-day bank bills is 2.50% p.a. (simple interest) and the current spot rate for 270-day bank bills is 2.80% p.a. (simple interest). Assume Emily can borrow or lend at the same rate as the yield rate of the bank bills.

a. [5 marks] Use two carefully labelled cash flow diagrams in your answer to set out the cash flows associated with the forward contract and the replicating portfolio to explain how you can determine the fair forward rate for this forward contract. Base your answer on the arbitrage pricing principle, and express the fair forward rate as an annual simple rate of interest, to 2 decimal places.