Siri Moon, portfolio manager, at Investment Management, Ltd., is conducting a training session with Alexa Sun, a junior analyst in the fixed income department. Siri wants to explain to Alexa the arbitrage-free valuation framework used by the firm. Siri presents Exhibit 1, showing a fictitious bond being traded on three exchanges, and asks Alexa to identify the arbitrage opportunity of the bond. Alexa agrees to ignore transaction costs in her analysis.

	Eurex	NYSE Euronext	Frankfurt
Price	EUD 103.7956	EUD 103.7815	EDU 103.7565

Siri shows Alexa some exhibits that were part of a recent presentation. Exhibit 3 presents most of the data of a binomial log-normal interest rate tree fit to the yield curve shown in Exhibit 2. Exhibit 4 presents most of the data of the implied values for a four-year, option-free, annual pay bond with a 2.5% coupon based on the information in Exhibit 3.

One-Year	Two-Year	Three-Year
1.25%	1.50%	1.70%

Current	Year 1	Year 2	Year 3	Year 4
1.2500%	1.8229%	1.8281%	2.6241%	Node 4-1
	1.4925%	Node 2-2	Node 3-2	4.2008%
		1.2254%	1.7590%	3.4393%
			Node 3-4	2.8159%
				Node 4-5

Year 0	Year 1	Year 2	Year 3	Year 4
Node 0-0	104.2876	103.2695	102.3791	102.5000
	Node 1-2	104.0168	102.8442	102.5000
		104.6349	103.2282	102.5000
			103.5448	102.5000
				102.5000

Siri asks about the missing data in Exhibits 3 and 4 and directs Alexa to complete the following tasks related to those exhibits:

• Task 1: Test that the binomial interest tree has been properly calibrated to be arbitrage-free.
• Task 2: Develop a spreadsheet model to calculate path-wise valuation. To test the accuracy of the spreadsheet, use the data in Exhibit 3 and calculate the value of the bond if it takes a path of lowest rates in Year 1 and Year 2 and the second-lowest rate in Year 3.
• Task 3: Identify a type of bond where the Monte Carlo calibration method should be used in place of the binomial interest rate method.
• Task 4: Update Exhibit 3 to reflect the current volatility, which is now 15%.

Question 1: Based on Exhibit 1, the best action that an investor should take to profit from the arbitrage opportunity is to (note: select buy or sell) on (note: select Eurex, Euronext, or Frankfurt), (note: select buy or sell) on (Note: select Eurex, Euronext, or Frankfurt) .

Question 2: Fill in blanks in Exhibit 3 and 4. (Note: Round up to the nearest ten thousandths: e.g. 102.51236 => 102.5124.)

• The Interest rate in Node 2-2 is %.
• The Interest rate in Node 3-2 is %.
• The Interest rate in Node 3-4 is %.
• The Interest rate in Node 4-1 is %.
• The Interest rate in Node 4-5 is %.
• The price of the bond in Node 0-0 is .
• The value in Node 1-2 is .