Question1

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

Bond	Coupon rate %	Time to maturity years	Yield to maturity %
A	4	1	5
B	6.5	2	6
C	8	3	8

Required

(a) Determine the prices of bonds A, B and C.

(b) Determine the current term structure of spot interest rates and briefly comment on the shape of the term structure.

(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.

(d) If the 3-year zero coupon bond in (c) has a market price of $780, show how you can eam an arbitrage profit. Make sure to clearly detail the arbitrage strategy.