Question 22 a)

Here are some zero-coupon rates for four different maturities using annual compounding:

1 year: 4% per annum 2 years: 5% per annum 3 years: 6% per annum 4 years: 7% per annum

(i) When using continuous compounding, find the corresponding rates per annum (ii) Explain why the annually compounded rates are higher than the continuously compounded rates. (iii) Work out the forward rates per annum when using continuous compounding. (iv) Explain the reasoning behind the calculation of forward rates. (v) What is the value of a Forward Rate Agreement (FRA) that promises to pay 4% per annum on a principal of 200 million for one year starting 2 years from now from the perspective of the lender? Explain.