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Sue plans to purchase a forward contract on a 7-year Treasury bond with a coupon rate of j2 = 4.5% p.a. and a face value
Sue plans to purchase a forward contract on a 7-year Treasury bond with a coupon rate of j2 = 4.5% p.a. and a face value of $100 that matures at par, to be delivered at the end of 12 months. The current spot yield rate for a 8-year Treasury bond(with a coupon rate of j2 = 4.5%) is j2 = 5.2% and the current spot rate for a one-year loan or deposit is j2 = 4.9%. a. [2 marks] Use the current spot rate, calculate the price of a 8-year Treasury bond with a coupon rate of j2 = 4.5% and a face value of $100 that matures at par. Round your answer to four decimal places. b. [2 marks] Draw a cash flow diagram representing the forward contract into which Sue wishes to enter. c. [5 marks] Use the arbitrage-free pricing principle to calculate the fair forward price for this forward contract. Round your answer to two decimal places. d. [2 marks] Explain how Sue can have an arbitrage opportunity for this forward contract and how Sue can exploit it (No calculation required.)
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