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Unformatted text preview: correct forward rate in half year: [ (
( )
) Because the real forward rate =5.0012% < 5.75%, there’s an arbitrage opportunity.
b) The arbitrage strategy is generally as follows:
Borrow $N money for 1 year, at the rate r1=5.5%, then long $N forward contract at forward rate 5.75%
after half year for the second half year. At the first half year, you invest money at rate r0.5=6.0%, and at
the second half year, invest at rate 5.75%, then, after one year, the amount of money I have is:
( )( And the interest cost for borrowing money is: ) ( ) So after one year, I can gain $0.00385625N from nothing, if the N is extremely large, I could gain a large
amount of money until the forward rate decrease to 5.0012%.
Question 5
1. Assuming the par value of each bond is $100 ( ) ( ) ( ( ) ) ( ) ) ( ) ( ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) Solve the discount factors first:
F1
F2
F3
F4
F5
F6
0.98692 0.97143 0.956317 0.940239 0.923021 0.905407 Then, we have the spot rate with different te...
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This document was uploaded on 02/15/2014 for the course CAREY BUSI Global Cap at Johns Hopkins.
 Spring '14

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