2 years is 13 You have 2250000 available to invest You obser

2. years is 13 You have $2,250,000 available to invest. You observe that the interest rate in markets for risk free investments for five .500, while that in markets for risk free investments for seven years is 9.5%. (3 points each for a total of 9 points) (i). Work out DF\'s, the discount factor for five years. (ii). Work out DF7, the discount factor for seven years. (ii). Determine whether or not there are risk free arbitrage opportunities here. Give reasons.

Solution

Discount factor = 1/(1+r)^n

(i)For 5 year DF5= 1/(1.135)^5= 0.53091

(ii)For 5 year DF7= 1/(1.095)^7= 0.52979

(iii) Discount Factor is the Present value of $1 invested at any rate for any period. Thus from answer i and ii we can calculate present value of investment $2250000 for both risk free rates

PV of investment at risk free rate of 5 Year = $2250000*0.53091= $1,194,546.91

PV of investment at risk free rate of 7 Year = $2250000*0.52979=$1,192,020.39

Since the present value of both investment is not equal ,we can confirm that there is risk free arbitrage opportunity