Question
Problem 1 Assume that: Forward rates for 6 month and 1 year are r(0.5)=7% and r(1)=8%; Spot rates for 18 months and 2 years are
Problem 1 Assume that:
Forward rates for 6 month and 1 year are r(0.5)=7% and r(1)=8%;
Spot rates for 18 months and 2 years are (1.5) =7.8% and (2)=8.2%
The price of a zero-coupon bond maturing 2.5 years from now is $81.50
A) (3 points) Find 2.5 years forward rate r(2.5)
B) (4 points) Assume 2-year 5% coupon bond and 2-year 7% coupon bond are priced correctly while 2-year zero coupon bond is incorrectly priced at $85. You want to make an arbitrage by trading only these 3 bonds. Find an arbitrage strategy (i.e., state how many of each bond you want to buy or sell)
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