You observe three bonds of identical credit quality, with a maturity of 3 years. All cash flows are expressed as percentages of face value. The spot rates in year 1,2 and 3 are 7%,8% and 9% respectively. a) Determine the no-arbitrage price of bonds A, B and C based on the spot rates in years 1, 2 and 3. Based on your results, comment on whether each of the bonds is correctly priced, overvalued or undervalued in the market. [5 marks] b) Derive a profitable arbitrage strategy based on the market prices of bonds A, B and C. What is the amount held of each bond, and the resulting arbitrage profit? Show full workings. [10 marks] (Question 3 continues on the next page) You observe three bonds of identical credit quality, with a maturity of 3 years. All cash flows are expressed as percentages of face value. The spot rates in year 1,2 and 3 are 7%,8% and 9% respectively. a) Determine the no-arbitrage price of bonds A, B and C based on the spot rates in years 1, 2 and 3. Based on your results, comment on whether each of the bonds is correctly priced, overvalued or undervalued in the market. [5 marks] b) Derive a profitable arbitrage strategy based on the market prices of bonds A, B and C. What is the amount held of each bond, and the resulting arbitrage profit? Show full workings. [10 marks] (Question 3 continues on the next page)