Answer: Borrow at the 3-year spot rate and lend at the 4-year spot rate to earn a return of GBP 28,000.

The correct answer to the question is A. The treasurer of the insurance company can lock in a return by borrowing at the 3-year spot rate and lending at the 4-year spot rate to earn a return of GBP 28,000. This is calculated using the forward rate formula: \[ F = \frac{R_{2}T_{2} - R_{1}T_{1}}{T_{2} - T_{1}} \] Where: - \( R_{2} \) is the 4-year spot rate (2%) - \( T_{2} \) is the time for the 4-year rate (4 years) - \( R_{1} \) is the 3-year spot rate (1.5%) - \( T_{1} \) is the time for the 3-year rate (3 years) Plugging in the values, we get: \[ F = \frac{0.02 \times 4 - 0.015 \times 3}{4 - 3} = 3.5\% \] This means the forward rate for the period from the end of year 3 to the end of year 4 is 3.5%. To earn this interest, the company would need to borrow GBP 800,000 today at 1.5% for 3 years and invest the proceeds at 2% for 4 years. After 3 years, the borrowed amount would be repaid, and the company would invest the remaining funds at the forward rate of 3.5% for 1 year, which would yield an interest income of GBP 28,000 on the GBP 800,000 invested.

Author: LeetQuiz Editorial Team