(b) You want to invest a sum of money for two years and have two alternatives:

Alternative 1: 3-year 5% coupon AAA bond selling at a par. Alternative 2: A AAA bank deposit which pays according to the following rates:

1 year spot rate 4.0%

1 year forward rate one year from now 4.5%

1 year forward rate two years from now 5%

Analyse the alternatives to determine which one is the better deal. (8 marks)