One‐year spot rates are 1% and two‐year spot rates are 2% assuming annual coupon payments. An analyst has derived the following interest rate tree: Time 0 Time 1 R 1.00% 2.46% By considering the price of a two‐year 5% annual coupon bond, determine which of the following interest rates would produce an arbitrage free tree:
a. 3.00%.
b. 3.23%.
c. 3.57%.