(7) In Example (8.3.3) we calculated the two-year spot rate and found r2 = 3.866088985%. Explain how there would be an arbitrage opportunity if therewas a two-year zero-coupon bond available with a yield rate of 3.5%

Example (8.3.3):

Problem:

A two-year bond pays annual coupons of $30 and matures at $1,000. Its

price is $984. The same corporation sells a one-year $1,000 zero-coupon bond for

$975. Compute the two-year spot rate r2?