Suppose a 10-year zero-coupon bond (zero) is trading spot at 6% and a 20-year zero is...

Suppose a 10-year zero-coupon bond (zero) is trading spot at 6% and a 20-year zero is trading spot at 8%. We know that the 10 year forward rate for a 10 year zero must be 0.1004 (annual compounding). All are risk free. If the rates are not 0.1004 for the forward you can make a free profit by using arbitrage.

Suppose you have $0 dollars today but are allowed to sell and buy $100,000 worth of zero coupon bonds (and commit to the forward 10 year zero coupon bond using any cash you have - or need to reborrow - after 10 years from your initial trades).

(a) What trades do you execute if the forward rate is 9% - report your profit.

(b) What trades do you execute if the forward rate is 11% - report your profit.

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ekkarill92 answered 1 year ago

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