Explanation:

The correct answer is B (99.86). The price of the bond is calculated using the spot rates as discount factors for each cash flow. The formula for the present value (PV) of the bond is:

$PV = \frac{PMT}{(1 + Z_1)^1} + \frac{PMT}{(1 + Z_2)^2} + \frac{PMT + FV}{(1 + Z_3)^3}$

Where:

• $PMT$ is the annual coupon payment (4).
• $FV$ is the face value of the bond (100).
• $Z_1, Z_2, Z_3$ are the spot rates for 1, 2, and 3 years, respectively (6%, 5%, 4%).

Substituting the values:

$PV = \frac{4}{(1 + 0.06)^1} + \frac{4}{(1 + 0.05)^2} + \frac{104}{(1 + 0.04)^3}$

Calculating each term:

1. $\frac{4}{1.06} = 3.77358$
2. $\frac{4}{1.1025} = 3.62812$
3. $\frac{104}{1.1249} = 92.4556$

Adding these together:

$3.77358 + 3.62812 + 92.4556 = 99.8573 \approx 99.86$

Why not A or C?

• A (97.28) is incorrect because it uses the average of the spot rates (5%) for all cash flows, which is not the correct method.
• C (100.00) is incorrect because it uses the 3-year spot rate (4%) for all cash flows, which is also not the correct method.