Question: a. Demonstrate using the 2-year on-the-run issue that the binomial interest rate tree above is in fact an arbitrage-free tree. b. Demonstrate using the 3-year

a. Demonstrate using the 2-year on-the-run issue that the binomial interest rate tree above is in fact an arbitrage-free tree. b. Demonstrate using the 3-year on-the-run issue that the binomial interest rate tree above is in fact an arbitrage-free tree.The on-the-run-issue for Inc.Net Company is shown below: Maturity (years) Yield to maturity (%) Market price 7.5 100 7.6 100 7.7 100 Using the bootstrapping methodology, the spot rates are as follows: Maturity (years) Spot rate (%) 7.500 7.604 7.710 Assuming an interest rate volatility of 10% for the 1-year rate, the binomial interest rate tree for valuing a bond with a maturity of up to three years is shown below: 9.603% 8.4814 7.5% 7.862% 6.944% 6.437%

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