You consider investing in the fixed income markets for diversification

purposes. There are two bonds you want to invest.

The first one is an option$-$free bond with a maturity of $5$ years. The bond

pays $7\%$ coupon at annual basis. Assume there is no accrued interest today.

The second one is a zero$-$coupon bond with a maturity of $3-$years.

You also require a yield of $9\%.$ The option$-$free bond is traded at $$920\mathrm{.}708$

and the zero$-$coupon bond at $778\mathrm{.}956?$ Which one would you like to buy

and why?

Buy Zero$-$Coupon Bond because it is underpriced.

Buy Zero$-$Coupon Bond because it is fairly$-$priced.

Buy Option$-$Free Bond because it is underpriced.

Buy Option$-$Free Bond because it is fairly$-$priced.