Arizona State University FIN FIN MISC Suppose that in the fixed-income securities market, the one-year,…
Suppose that in the fixed-income securities market, the one-year, two-year, and three-year spot interest rates are 6.000%, 6.500%, and 7.000%, respectively. (That is, R0,1 = 6.000%, R0,2 = 6.500% , and R0,3 = 7.000%.) . In addition, in the forward interest rate market, the one-year forward rate two-years from now (F2,1) is 8.500%.
Assume that an arbitrager can borrow or lend exactly $1,050 in the forward interest rate market. She generates an arbitrage strategy such that her net cash flows Now (t=0), at the end of Year 1 (t=1), and at the end of Year 2 (t=2) are equal to zero. However, she generates some positive cash flow at the end of Year 3 (t=3). What is the maximum amount of her net cash flow at the end of Year 3 (t = 3)?
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