You compiled pricing data for two semi-annual coupon payment Treasury bonds (Table 1). Each of the bonds will mature in two years, the Treasury spot rates are shown in Table 2.(30 marks)

Table 1: Market data for selected bonds

Asset

Coupon

Market price

Bond A

7%

96.568

Bond B

9%

101.022

Table 2: Treasury spot rates

Period

Rates

Six months

6%

One year

7%

One and half year

8%

Two years

9%

1)Calculate the arbitrage-free prices of Bond A and Bond B(10 marks)

2)Which bond will provide an arbitrage opportunity and what is the arbitrage profit?(1 mark)

Next, you want to use the benchmark yield curve provided in Table 3 toidentify investmentopportunities associated with two annual coupon corporate bonds. The benchmark bonds pay coupons annually and the bonds are priced at par. Table 4 provides the market data of the two corporate bonds.

Table 3: Benchmark Par Curve

Maturity (years)

Yield to Maturity

1

4%

2

5%

3

6%

Table 4: Market data forthe corporatebonds

Company

Coupon

Maturity (years)

Market price

X

9%

3

108.117

Y

19%

3

109.794

3)Calculate the arbitrage-free prices of Bond X and Bond Y(18 marks)

4)Which bond ismispriced and what is the amount of the mispricing?(1 mark)