Quantitative Finance

Exercise 1 (1 mark for (a), 2 marks for (b). Assume all rates are annually compounded. The one-year, two-year, and three-year zero rates are 1.25%, 1.5%, 1.75% respectively. (a) Compute the two-year forward one-year rate. This is the forward rate for the period starting 2 years from now and ending 1 year after that. (b) Suppose the one-year forward two-year rate is 2.1%. Determine if there is an arbitrage opportunity. If so, find an arbitrage portfolio. Make sure that you verify the portfolio is an arbitrage portfolio