Answer: spot curve.

## Explanation **Correct Answer: A** **Spot curve** (also known as the zero-coupon yield curve) is used for arbitrage-free valuation because: 1. **Each cash flow is discounted at its own appropriate rate**: The spot rate for each maturity period reflects the time value of money for that specific time horizon 2. **Eliminates arbitrage opportunities**: Using a single yield-to-maturity would create pricing inconsistencies, as different cash flows have different risk characteristics 3. **Proper risk assessment**: Corporate bonds require adding appropriate credit spreads to government spot rates to account for default risk **The arbitrage-free valuation process:** - Start with the government spot curve - Add appropriate credit spreads for the corporate bond's rating and maturity - Discount each cash flow using the corresponding spot rate plus credit spread - Sum the present values to get the bond's fair value This approach ensures that bonds with the same risk characteristics but different cash flow patterns are priced consistently.

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