Suppose that the annual yield to maturity for the 6-month and 1-year Treasury bill is 4.4% and 4.8%, respectively. These yields represent the 6-month and 1-year spot rates. Also assume the following Treasury yield curve (i.e., the price for each issue is $100) has been estimated for 6-month periods out to a maturity of 3 years:

 

Years to Maturity  .........Annual Yield to Maturity (BEY) 

1,50.............................................5,20% 

2....................................................5,50% 

2.50...............................................6,00% 

3.....................................................6,40% 

 

a) Compute the 1.5-year, 2-year, 2.5-year, and 3-year spot rates on a bond equivalent yield basis. 

b) Given these spot rates, compute the arbitrage-free value of a 3-year Treasury security that pays semi- annual coupons with a coupon rate of 7%.