The market one-year, strip (zero) spot rate is 4

Finance Dec 22, 2020

The market one-year, strip (zero) spot rate is 4.5%, and the forward rate from year one to year two (meaning for lending/borrowing money in a year for one more year) is 3.5%. Today, an individual is willing to lend or borrow money for two years at an annual rate of 4.6%. Is there an arbitrage opportunity? If yes describe it.

Expert Solution

the two year spot rate should be = (1.045*1.035)^1/2 - 1

clearly the market rate offers a lower rate of return than the individual

therefore, an arbitrage exists in which money can be borrowed from the market and lent to the individual

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