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Arbitrage Using Term-Structure
In year 0, the current term-structure of spot rates are as follows (with continuous compounding):
Maturity (years)
Spot rate (% per annum)
1
3.0
2
4.0
A bank offers special bond A where investors can borrow (lend) $100 in year 1 and repay (receive) $100 x e0.06 in year 2. Construct an arbitrage where we use bond A and zero-coupon bonds, and show the arbitrage strategy using a table listing asset positions and cash flows. In particular, present an arbitrage that results in zero net cash flow in both year 0 and year 1 and positive net cash flow in year 2.
[Hint. Compare the implied forward rate r0(1, 2) from the term structure to the interest rate on the bond A.]
Finance is about Gunns Ltd, a company in dealing with forestry products in Australia. The company has also been listed in Australian Stock Exchange. As many companies producing forestry products, even Gunns Ltd is facing various problems. Due to the ..
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