Please give me detailed information because I need to know how to solve it with
ID: 2759489 • Letter: P
Question
Please give me detailed information because I need to know how to solve it with my own hands.
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l serisituvity of yteld. the bond However, tis not a perfect measure of bon pri ensitivity, Esplain price w.r.t. changes in Question 11. You have estimated spot interest rates as follows Year Spot Rate Percent r(0,1) = r(0, 2) = r(0,3) = r(0, 4) = r(0, 5) = 5.00 5.40 5.70 5.90 6.00 1. Suppose that someone told you that the 6-year spot interest rate was 4.80 percent. (a) Why would you not believe him? ow could you make money if he was right? (c) What is minimum sensible value for the 6-year spot rate? n 12Explanation / Answer
Answer:11 A 6-year spot rate of 4.8 percent implies a negative forward rate:
(1.048 6 /1.06 5 ) – 1 = –0.010 = –1.0%
To make money, you could borrow $1,000 for 6 years at 4.8 percent and lend $990 for 5 years at 6 percent. The future value of the amount borrowed is:
FV 6 = $1,000 × (1.048) 6 = $1,324.85
The future value of the amount loaned is:
FV 5 = $990 × (1.06) 5 = $1,324.84
This ensures enough money to repay the loan by holding cash over from year 5 to year 6, and provides an immediate $10 inflow.
The minimum sensible rate satisfies the condition that the forward rate is 0%:
(1 + r 6 ) 6 /(1.06) 5 = 1.00
This implies that r 6 = 4.976 percent.