Question 2. Suppose the current ZCB prices for maturity in two years and in five years are 0.8 and 0.7, respectively. Suppose the two-year forward three-year libor rate is 4%. Determine if there is an arbitrage opportunity. If so, find an arbitrage portfolio. Make sure that you verify the portfolio is an arbitrage portfolio. Hint: In your arbitrage portfolio you will need to include a forward rate agreement.

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Question 2. Suppose the current ZCB prices for maturity in two years and in five years are 0.8 and 0.7, respectively. Suppose the two-year forward three-year libor rate is 4%. Determine if there is an arbitrage opportunity. If so, find an arbitrage portfolio. Make sure that you verify the portfolio is an arbitrage portfolio.

Hint: In your arbitrage portfolio you will need to include a forward rate agreement.

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