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    Forward rates, Arbitrage

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    Please see attachment for tables and pre-question information.

    Questions:

    Data:
    Suppose the following coupon info

    Maturity (year) Coupon Rate price
    1 0% 97
    2 3.00% 99
    2 0% 91
    3 4.00% 98
    3 0% 87
    Please note there are arbitrage opportunities (shown below).

    The 1-yr rate implied by the 1-yr zero coupon bound is
    = 100/97 - 1 = 3.09%
    The 2-yr rate implied by the 2-yr zero coupon bound is
    91 = 100/ = - 1 = 4.828%
    The 2-yr rate implied by the 2-yr coupon bound is
    99 = = 3.5%
    The 3-yr rate implied by the 3-yr zero coupon bound is
    87 = 100/ = - 1 = 4.75%
    The 3-yr rate implied by the 3-yr coupon bound is
    98 = = 4.75%

    The 2-year rates implied by coupon bond is different to those implied by zero coupon bonds. Hence there is arbitrage opportunity for this segment of term structure.

    Questions:

    1. Is there any other arbitrage opportunity?
    2. Given above bonds, what are the implied forward rates?
    3. If one was to invest $1,000 two years from now for one year. Which would be the best strategy (what forward rate to use)? What is the return?

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    https://brainmass.com/business/arbitrage-pricing-theory/forward-rates-arbitrage-14812

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    Solution Summary

    The solution identifies arbitrage opportunities and calculates the implied forward rates.

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