Given 1-year, 2-year, 3-year par rates (or yield-to-maturity) of an institutions bonds are 2%,

3%, 4%,

(a) find the 1-year, 2-year, 3-year spot rates. Use these spot rates to price a fixed rate 3-year 5% coupon bond issued by the same institution.

(b) Suppose interest rate volatility is incorrectly perceived by the market as 15% p.a. when it should be 20% p.a., can you make arbitrage profits by trading in these institutions bonds

?