hypothetical Callable bond (C) and Putable bond of ABC Corporation. .Both bonds have annual coupon rates of 10%, face values of $1000 and 2 years to maturity. Coupons are paid annually. The callable bond (C) can be called at par, only at the end of the first period (right after the coupon payment). Similarly, the putable bond (P) can be put at par, only at the end of the first period (right after the coupon payment). The callable bond and the putable bond are now traded at $970 and $1020, respectively. All bonds in this question are risk free

you can buy and short sell (borrow and sell) C, P and T-strips without transactions costs. You forecast that interest rate will change in the future one year from now, the yield to maturity on one year T-strips at that time will not be 10% for sure. The 1-year and 2-year T-strips both trade at a yield to maturity of 10% (Effective Annual Yield).

1. If the callable bond will never be called and putable bond never be put, what should be their current prices?

2. Show that there is an arbitrage opportunity.