The current one-year and two-year spot rates are 6% and 7%, respectively. Compounding is annual. The model
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The current one-year and two-year spot rates are 6% and 7%, respectively. Compounding is annual. The model you are using prescribes that in a risk-neutral setting, the next period’s one-year interest rates will be either 8% or 5%. No risk-neutral probabilities are given. Does the modeling situation present an arbitrage? Why?
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