Question: Question 3 Consider the following information in Table 2, on three default-risk free bonds with annual coupon payments and face value of $1,000. Table 2

Question 3 Consider the following information in Table 2, on three default-risk free bonds with annual coupon payments and face value of $1,000. Table 2 Bond Coupon rate (%) Time to maturity (years) Yield to maturity (%) A 4 5 B 6.5 2 6 C 8 8 (a) Determine the prices of bonds A, B and C. (3 marks) (b) Determine the current term structure of spot interest rates and briefly comment on the shape of the term structure. (5 marks) (c) Demonstrate how you can use bonds A, B and C to replicate a 3-year zero coupon bond with a face value of $1,000. (6 marks) d) If the 3-year zero coupon bond in (c) has a market price of $780, show how you can earn an arbitrage profit. Make sure to clearly detail the arbitrage strategy. (6 marks)

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