Mock Exam pm: Fixed Income Q43

CFA Official 2018 Level 2 mock exam PM (Solution p41)

Question:

Govt bond with a 3.2%, annual pay coupon maturing in three years. the bond is quoted in the market at $103.50.

Year 1 Year 2 Year 3

Spot Rate 1.1% 1.5% 2.01%

Par Rate 1.1% 1.5% 2.00%

Forward Rate 1.1% 1.91% 3.04%

Profitable arbitrage opportunity?

Answer:

Year 1: 3.20 / (1.011)1 = 3.1652

Year 2: 3.20 / (1.01504)2 = 3.1059

Year 3: 103.2 / (1.02013)3 = 97.2105

103.4816 = 3.1652 + 3.1059 + 97.2105

So, strips could be purchased for $103.4816 and reconstituted into the bond, which could be sold for $103.5, representing an arbitrage opportunity.

My question is how to get the rate 1.01504 & 1.02013 and why? Please help!

which mock exam?

CFA Official 2018 Level 2 mock exam PM (Solution p41)

Thanks!

As far as I can see, it’s just the CFs discounted at spot rates. I think they didn’t display all the decimal places in the question stem.

I solved this with the spot rate and i got the same answer , in case you wish to see all decimals solve the par rates ( but why would i do hat when i am given spot rates? so i would just plug the spot rates)