# Question

For years 2–5, compute the following:

a. The forward interest rate, rf , for a forward rate agreement that settles at the time borrowing is repaid. That is, if you borrow at t − 1 at the 1-year rate ˜r, and repay the loan at t , the contract payoff in year t is (˜r − rf )

b. The forward interest rate, re, for a Eurodollar-style forward rate agreement that settles at the time borrowing is initiated. That is, if you borrow at t – 1 at the 1-year rate ˜r, and repay the loan at t , the contract payoff in year

t − 1 is (˜r − re)

c. How is the difference between rf and re affected by volatility (you can compare the two trees) and time to maturity?

a. The forward interest rate, rf , for a forward rate agreement that settles at the time borrowing is repaid. That is, if you borrow at t − 1 at the 1-year rate ˜r, and repay the loan at t , the contract payoff in year t is (˜r − rf )

b. The forward interest rate, re, for a Eurodollar-style forward rate agreement that settles at the time borrowing is initiated. That is, if you borrow at t – 1 at the 1-year rate ˜r, and repay the loan at t , the contract payoff in year

t − 1 is (˜r − re)

c. How is the difference between rf and re affected by volatility (you can compare the two trees) and time to maturity?

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