The yield to maturity (YTM) on 1-year zero-coupon bonds is 6% and the YTM on 2-year zeros is 7%. The yield to maturity on 2-year-maturity coupon bonds with coupon rates of 9% (paid annually) is 6.5%.

a.What arbitrage opportunity is available for an investment banking firm?

The arbitrage strategy is to buy zeros with face values of $and $, and respective maturities of one year and two years.

b.What is the profit on the activity?