Question

Suppose we have the following current spot rate curve: 6-month spot rate: 4%. 12-month spot rate: 10%. Despite the above spot rate curve, an investor firmly believes that the 6-month spot rate in 6 months will be 5%, and that she can borrow and invest $5,069 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

t=0: Borrow 5069 for 6 months at 4% and Invest 5069 for 12 months at 10%

t=6 months: Pay 5069*(1+4%/2)=5170.38 using again borrowing money for 6 months at 5%

t=12 months: Pay 5170.38*(1+5%/2)=5299.64 using amount returned from investment. Invested amount becomes 5069*(1+10%/2)^2=5588.57

Net Profit=5588.57-5299.64=288.93