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Problem 1 (10 points). The following table depicts current market conditions (assume annual compounding): Year Current spot rates (rt) Implied 2-year forward rate (ft,2) 3 2.00% 4 3.00% 5 3.80% 6 4.00% N/A 7 4.10% N/A (a) Calculate implied 2-year forward rates (f3,2, f 4,2, f5,2). (b) According to your analysis on the market condition, propose a strategy that goes long a zero coupon bond and goes short another zero coupon bond. For simplicity, use only zero coupon bonds. (c) According to (b), we will go long a m-year zero coupon bond and go short a n-year zero coupon bond. From mathematical analyses, we already know that the m-year zero coupon bond outperforms the n-year zero coupon bond whenever the forward rate between the m- and n-year bond rises after 1 year. Here are our scenarios: Current State Steepening Parallel Shift Flattening m-year spot rates (rm) x % x % X + 0.3% x + 0.3% n-year spot rates (rn) y % y + 0.5% y + 0.3% y + 0.1% In which situation(s) do we make a profit from our strategy? Problem 1 (10 points). The following table depicts current market conditions (assume annual compounding): Year Current spot rates (rt) Implied 2-year forward rate (ft,2) 3 2.00% 4 3.00% 5 3.80% 6 4.00% N/A 7 4.10% N/A (a) Calculate implied 2-year forward rates (f3,2, f 4,2, f5,2). (b) According to your analysis on the market condition, propose a strategy that goes long a zero coupon bond and goes short another zero coupon bond. For simplicity, use only zero coupon bonds. (c) According to (b), we will go long a m-year zero coupon bond and go short a n-year zero coupon bond. From mathematical analyses, we already know that the m-year zero coupon bond outperforms the n-year zero coupon bond whenever the forward rate between the m- and n-year bond rises after 1 year. Here are our scenarios: Current State Steepening Parallel Shift Flattening m-year spot rates (rm) x % x % X + 0.3% x + 0.3% n-year spot rates (rn) y % y + 0.5% y + 0.3% y + 0.1% In which situation(s) do we make a profit from our strategy