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.

(c) Comment on why the forward rate must be 10.04% in light of your results.

Expert Solution

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.

ekkarill92 answered 2 years ago

Suppose a 10-year zero-coupon bond (zero) is trading spot at 5% and a 20-year zero is...

Suppose a 10-year zero-coupon bond (zero) is trading spot at 5% and a 20-year zero is trading spot at 7%. In lectures (L4.9) we proved that the 10 year forward rate for a 10 year zero must be 0.0904 (annual compounding). All are risk free. If the rates are not 0.0904 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...

Suppose that the spot interest rate on a one-year zero-coupon bond is 2% and the spot...

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Suppose that the spot interest rate on a one-year zero-coupon bond is 1%, and the spot...

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Suppose a one-year zero-coupon bond with face value $100 is trading at $90.909. The corresponding YTM...

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Consider a five year bond with a 10% coupon that is presently trading at a yield...

Consider a five year bond with a 10% coupon that is presently trading at a yield to maturity of 8%. If market rates do not change, one year from now the price of this bond _____________. Will be higher Will be lower Will be the same Cannot be determined from the information given A bond’s sensitivity to interest rate changes _____________ at a(n) _______________ rate as maturity lengthens. increases; decreasing decreases; decreasing increases, increasing decreases, decreasing

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