Question 1 (10 marks) Suppose a 10-year zero-coupon bond (zero) is trading spot at 5% and a 20-year zero is trading spot at 7%. In lectures (L4.9) we proved that the 10 year forward rate for a 10 year zero must be 0.0904 (annual compounding). All are risk free. If the rates are not 0.0904 for the forward you can make a free profit by using arbitrage. Suppose you have $0 dollars today but are allowed to sell and buy $100,000 worth of zero coupon bonds (and commit to the forward 10 year zero coupon bond using any cash you have - or need to reborrow - after 10 years from your initial trades). (a) What trades do you execute if the forward rate is 8% - report your profit. (b) What trades do you execute if the forward rate is 10% - report your profit. (c) Comment on why the forward rate must be 9.04% in light of your results. Question 1 (10 marks) Suppose a 10-year zero-coupon bond (zero) is trading spot at 5% and a 20-year zero is trading spot at 7%. In lectures (L4.9) we proved that the 10 year forward rate for a 10 year zero must be 0.0904 (annual compounding). All are risk free. If the rates are not 0.0904 for the forward you can make a free profit by using arbitrage. Suppose you have $0 dollars today but are allowed to sell and buy $100,000 worth of zero coupon bonds (and commit to the forward 10 year zero coupon bond using any cash you have - or need to reborrow - after 10 years from your initial trades). (a) What trades do you execute if the forward rate is 8% - report your profit. (b) What trades do you execute if the forward rate is 10% - report your profit. (c) Comment on why the forward rate must be 9.04% in light of your results