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This is an exam question that I cannot answer using my textbook so I came to this site for help:

Assume that I can buy a 2, 2 forward rate of 11% at the stock market, that is in two years I can deposit my money for two years at a 11% interest rate.

Assuming further that my local bank offered me to deposit my money in two years for two years at 12% interest rate, so basically the same thing but I cannot "trade" this offer to other people because it is a personal offer to me.

Assuming further that I can borrow and lend money at some interest rate, let's say 8% or something.

Question: Is there any way that an investor could gain from those different interest rates for the forward? Any answers are highly appreciated! Thanks a lot in advance.

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  • I just found one possibility: That would be to offer a 2,2 forward to the market at 11% and at the same time to take the banks offer of a 2,2 forward at 12%. That is, assuming that I can also offer forwards to the market and not only buy them. Also I assumed that the underlying sum of money is equal in both cases (market and bank) – Alon Aug 17 at 17:57
  • If the forward rate is 11%, that means you can also borrow in 2 years at 11%. Do that and deposit the money in the 12% account. – farnsy Aug 18 at 15:50
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If you are allowed to go short, fun can be had.

You could just take the 12% offer and short (write) the 2,2 forward at 11%, pocketing in the 1% spread.

Even better, borrow at 8% for both contracts (go short at 8%) and go long both 12% and 11% forwards, getting even more spread for yourself.

Hope I got your question right.

  • For the last alternative you suggest, why not short the 8% and go long the 12%? I don’t see any benefit in going long the 11% as well - that’s just leaving 1%on the table. – Lawrence Aug 20 at 2:23
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    I was assuming a limited number of 12% contracts. But if you do find a counterparty willing to write you all the 12s you want while you borrow at 8%, then that's the way to go. But the spreads will eventually narrow to 0. – Gelinator Aug 27 at 14:02

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