Question

Suppose we have the following current spot rate curve:

• 6-month spot rate: 7%.
• 12-month spot rate: 9%.

Despite the above spot rate curve, an investor firmly believes that the 6-month spot rate in 6 months will be 4%, and that she can borrow and invest $3,320 at any of the current market rates. How much profit can this investor expect to make using the entire borrowed amount if her belief turns out to be true?

Round your answer to 2 decimal places.

Answer 1

Given

6-month spot rate = 7%.

12-month spot rate = 9%.

Invest for 1 year, we get after 1 year =$3,320 *(1+ (9%/2))²

⁼ $3,320 *(1+0.045)²

= $ 3625.523

investor firmly believes that the 6-month spot rate in 6 months will be 4%,

return will be

=$3,320*(1+(0.07/2)) * (1+(0.04/2))

=$3,320*(1.035) * (1.02)

=$3,504.924

Profit = $ 3625.523 - $3,504.924

Profit = $ 120.60