The current 1-year spot rate (S₁) is 5%, the 1-year forward rate for lending from year 1 to year 2 (f(1,1)) is 6%, and the 1-year forward rate for lending from year 2 to year 3 (f(2,1)) is 7%. Consider a bond with a coupon rate of 5% that pays annual interest and matures in three years. The face value of the bond is $1,000. Assume the bond has the same liquidity and risk as the benchmark rates given. The arbitrage-free value the bond is closest to:

Group of answer choices

$1,000.98

$1,027.75

$974.22

$922.64

Answer rating: 100% (QA)

To calculate the arbitragefree value of the bond you can use the concept of the noarbitrage pricing ... View the full answer