Explanation

In a risk-neutral framework, the price of a zero-coupon bond is calculated as the present value of its face value using risk-free rates. For a 2-year zero-coupon bond with $1 face value, the price would be:

$P = \frac{1}{(1 + r)^2}$

Where $r$ is the appropriate risk-free rate.

Among the given options:

• $0.88113 corresponds to a higher discount rate
• $0.88634 and $0.89032 are also possible prices depending on the specific risk-free rate used
• $0.89007 is the correct answer as it represents the appropriate present value calculation under risk-neutral assumptions

The risk-neutral pricing approach assumes that investors don't require compensation for risk, so they discount future cash flows at the risk-free rate only. This is a fundamental concept in fixed income pricing and derivatives valuation.