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Zero-coupon default-free interest rates maturing over the next five years are listed below (in percent per annum, continuously-compounded):

Maturity Years -- Yield

1 --------------------1.9

2 --------------------2.2

3 --------------------2.5

4 --------------------2.8

5 --------------------3.4

You expect to inherit $50 million at the end of year two, and would like to invest it for two additional years in the safest possible instrument in real terms. What is the safest investment and its rate of return?

a) Execute a forward loan at 3.4%

b) Lend for four years at 2.8%

c) Execute a forward loan at 3.7%

d) Wait two years and lend for two years

I think I know what to do when the interest rate is constant but I'm not sure what to do when it changes like this. Since the 50$ million inflow is coming in at the end of year 2, do I start looking at the table from year 3?

Any help appreciated!

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closed as off-topic by LocalVolatility, Bob Jansen Oct 29 '16 at 14:46

This question appears to be off-topic. The users who voted to close gave this specific reason:

  • "Basic financial questions are off-topic as they are assumed to be common knowledge for those studying or working in the field of quantitative finance." – LocalVolatility, Bob Jansen
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  • $\begingroup$ Anyone have any idea? $\endgroup$ – Alex T. Oct 29 '16 at 10:12
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    $\begingroup$ I am voting to close as this is a very basic question and thus off topic. Any introductory textbook will help you here. See e.g. Chapter 4 "Interest Rates" in Hull's "Options Futures and Other Derivatives" and look for "forward rates". $\endgroup$ – LocalVolatility Oct 29 '16 at 12:22
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Safest would be FRA to lock the interest rates.

Thanks

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  • $\begingroup$ So it would be either A or C? How would I calculate the return in those cases? $\endgroup$ – Alex T. Oct 29 '16 at 1:29
  • $\begingroup$ This is really getting too basic. $\endgroup$ – Bob Jansen Oct 29 '16 at 14:45

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