a. What spot and forward rates are embedded in the following Treasury bonds? The price of one-year strips is 93.46%. Assume for simplicity that bonds make only annual payments. ( Hint: Can you devise a mixture of long and short positions in these bonds that gives a cash payoff only in year 2? In year 3?)

Maturity (years) Coupon (%) Price (%)

4 2 94.92 8 3 103.64

b. A three-year bond with a 4% coupon is selling at 95.00%. Is there a profit opportunity here? If so, how would you take advantage of it?

AppendixLO1