Question: (i) A forward contract with 9 months to maturity is written on an underlying bond. The market price of the bond is $95, and it

  1. (i) A forward contract with 9 months to maturity is written on an underlying bond. The market price of the bond is $95, and it is expected to pay coupons of $5 after 3 months and $5 immediately prior to maturity. The relevant riskless rate of interest is 3%. Calculate the theoretical forward price and initial value of the forward contract and explain the forward pricing relationship.

(ii) Provide a numerical example of an arbitrage strategy for situations where the forward is trading above, and below the theoretical forward price.

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