 # another derivative question

A 4 percent Treasury bond has 2.5 years to maturity. Spot rates are as follows: 6 month 1 year 1.5 years 2 years 2.5 years 2% 2.5% 3% 4% 6% The note is currently selling for \$976. Determine the arbitrage profit, if any, that is possible. A) \$19.22. B) \$43.22. C) no profit is possible as the present value of expected cash flows equals the current market price. D) \$37.63. ************** The answer is A. But I still don’t understand the explanation given by schweser. Could someone please elaborate? Thanks,

20/(1.01^1) 20/(1.0125^2) 20/(1.015^3) 20/(1.02^4) 1020/(1.03^5) sum=956.77 976-956.77=19.22 Think of each payment coupon and principal as a series of zero coupon at the rate described. so 4 series of zero coupons at 20\$ discounted at it’s respective rate and 1020\$ at the 2.5 year rate should equal the cost of the bond, else there will be arbitrage opportunities

Thank you so much xck2000. That makes much more sense. The payments are discounted semi-annually. As long as I can figure out what the price should be. I can determine the actual arbitrage amount given the actual price in the market. Thanks again