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In May 2012, a bank will issue a 4/7 FRA referenced to BBSW with a...

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Finance

In May 2012, a bank will issue a 4/7 FRA referenced to BBSW with a guaranteed rate of 4.5% p.a.. Bank bill futures for September 2012 delivery are priced at 95.75. Assume there are no transaction costs and no spread between FRA borrowing and lending rates, and 30-day months.

i) Identify a strategy based on one futures contract which will yield an arbitrage profit, and

ii) Demonstrate how this will be achieved and calculate the net gain (or loss) from this strategy if the 90-day bank bill rate turns out to be 6% in September 2012.

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