Problem 2 (Weight 40%; each question weighted equally) Consider the following two notes. Note A has a remaining maturity of 90 days and is priced to yield an annualized return of 2.5%. Note B has a remaining maturity of 180 days and is priced to yield an annualized return of 3%. Both notes have face value 100, and neither note pays coupons. a) Find the current market values of the two notes. b) You use the two notes to create yourself a 90-day forward loan of NOK 100 starting 90 days from now. Calculate the (implicit) interest rate on your loan. Calculate also the value of the loan today. c) In 20 days interest rates change to 2.7% for note A and 3.3% for note B. Both rates are annualized. Calculate the value of your forward loan after these 20 days. Consider the following yield curve based on zero-coupon bonds with face values 100: Maturity yield 3.0% 3.5% 3 4.0% d) Assume that the expectations theory of the yield curve holds. Calculate the expected yield curve one year hence. e) As a mean-variance investor, which of the bonds above would you prefer. Does your investment horizon matter? f) A bank offers the following three forward rate agreements (FRA): . from time 1 to time 2 at an interest rate of 4% . from time 2 to time 3 at an interest rate of 4.8% . from time 1 to time 3 at an (annualized) interest rate of 4.5%. Do these FRAs represent any arbitrage opportunities? If so, show the trans- actions that you need to undertake in order to earn arbitrage profits. Show that these transactions do indeed yield arbitrage profits