Consider a 5-year coupon government bond. This bond has a 4% coupon rate, a par value of 100 and the coupon payment frequency is annual. The bond is priced at 107.1628 with a 2.46% yield.

a) Determine if this 5-year coupon government bond is expensive or cheap relative to the spot rate curve presented in table 2.

b) Howwouldyoutakeadvantageofthisinvestmentopportunity? Explain your answer clearly.

Table 2. Zero-coupon government bond prices and implied spot rates.

Maturity in years

Maturity value

Zero-Coupon Bond Price

Implied Spot Rate

1 100

2 100

3 100

4 100

5 100

99.2063 0.80% 97.4498 1.30% 94.7887 1.80%

91.3056 2.30% 87.3154 2.75%

Note: The implied spot rates in table 2 have been calculated using the annual coupon payment frequency assumption.

[8 marks]