Correct answer: D. 3.51%

For a 2-year par bond with semiannual coupons, the coupon rate $c$ satisfies:

$$100 = \frac{100c}{2}e^{-0.02(0.5)} + \frac{100c}{2}e^{-0.025(1.0)} + \frac{100c}{2}e^{-0.03(1.5)} + \left(100 + \frac{100c}{2}\right)e^{-0.035(2.0)}$$

Using the discount factors:

• $e^{-0.01} \approx 0.99005$
• $e^{-0.025} \approx 0.97531$
• $e^{-0.045} \approx 0.95600$
• $e^{-0.07} \approx 0.93239$

Solving for $c$ gives approximately 3.51%.

So the two-year par yield is 3.51%.