The effective annual yield on a one-year zero coupon bond is 8% and the effective annual interest rate on a two-year zero coupon bond is 8.5%. You are able to arrange a one-year forward loan at rate i for a one-year period. Suppose that under these conditions it is possible to make a riskless profit with the following strategy: (i) borrow amount 1 for one year at 8% effective annual, (ii) invest amount 1 for 2 years at 8.5% per year effective annual, (iii) arrange a one-year forward one-year length loan of amount 1.08 at rate i (starting one year from now) and repay the loan in (i),

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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and the effective annual interest rate on a two-year zero coupon
6.4.5 The effective annual yield on a one-year zero coupon bond is 80,
and the effective annual interest rate on a two-year zero coupon
bond is 8.5%. You are able to arrange a one-year forward loan
rate i for a one-year period. Suppose that under these conditions it
is possible to make a riskless profit with the following strategy:
(i) borrow amount 1 for one year at 8% effective annual,
(ii) invest amount 1 for 2 years at 8.5% per year effective annual,
(iii) arrange a one-year forward one-year length loan of amount
1.08 at rate i (starting one year from now) and repay the
loan in (i),
(iv) use the proceeds from (ii) to repay loan (iii) at the end of
the second year.
vai by
For what full range of i will this strategy result in a positive
amount left over after all 3 transactions are settled at the end of
the second year?
Transcribed Image Text:and the effective annual interest rate on a two-year zero coupon 6.4.5 The effective annual yield on a one-year zero coupon bond is 80, and the effective annual interest rate on a two-year zero coupon bond is 8.5%. You are able to arrange a one-year forward loan rate i for a one-year period. Suppose that under these conditions it is possible to make a riskless profit with the following strategy: (i) borrow amount 1 for one year at 8% effective annual, (ii) invest amount 1 for 2 years at 8.5% per year effective annual, (iii) arrange a one-year forward one-year length loan of amount 1.08 at rate i (starting one year from now) and repay the loan in (i), (iv) use the proceeds from (ii) to repay loan (iii) at the end of the second year. vai by For what full range of i will this strategy result in a positive amount left over after all 3 transactions are settled at the end of the second year?
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