The third act is set in Petkoff's library. There, Bluntschli diligently studies maps, Sergius struggles with his work, Major Saranoff relaxes with a newspaper and hookah, and Catherine embroiders near the stove while Raina, lost in thought, gazes out the window. Petkoff offers his assistance to Bluntschli, and the Swiss captain, an efficient multitasker, declines. Sergius watches Bluntschli's rapid work with a mixture of envy and admiration.

Petkoff says that he would like to wear his coat but cannot find it. Catherine, having taken it from Bluntschli's luggage, tells her husband it is in the closet. Petkoff says he already looked there. Nicola then retrieves the coat, and Petkoff concludes he is simply getting forgetful in his old age.

When Bluntschli finishes his work, Sergius and Petkoff leave to deliver the orders with Catherine in tow. Now that they are alone, Raina says that Bluntschli looks better than when they last met. Their conversation turns to Bluntschli's safe return and the aftermath of the escape. Raina tells him that their last meeting has been fueling the rumor mills in the military camps; even Sergius and her father have heard about it. Concerned, Bluntschli implores her not to tell Sergius, who might challenge him to a duel. Raina feels the weight of her deceit and emphasizes her commitment to honesty in her relationship with Sergius. However, Bluntschli is less troubled by the idea of dishonesty and attempts to reassure her that lying is sometimes acceptable.

Raina is curious about Bluntschli's impressions of her and asks about the portrait she left in the coat for him to find. Bluntschli says he never found it, leading them to worry that it could still be in the coat that Petkoff is currently wearing. Louka enters with letters and telegrams for Bluntschli. One of them carries the news that his father has died. Raina expresses sympathy, but Bluntschli is preoccupied with the financial implications of his inheritance.

After Raina and Bluntschli leave the library, Nicola enters and scolds Louka for wearing sleeves, which she does to hide the bruises on her arm. He then considers that it may be advantageous for him if Louka marries Sergius; if Nicola were to become Sergius’ servant, he could exploit the other man, as he is a "fool" when it comes to handling finances. This insight leads Nicola to contemplate the prospect of Louka marrying Sergius, imagining that with Sergius as his master, he could potentially secure a more prominent and comfortable position.

Nicola exits and Sergius enters. He confronts Louka about the bruise on her arm—which he caused during their earlier encounter. Louka, despite being hurt, maintains her composure and refuses Sergius' offer to treat the bruise. Sergius attempts to exert his authority over her and subtly threatens to make her obey. The exchange escalates as Sergius questions Louka's understanding of courage. She is quick to fire back, however, challenging Sergius' notions of bravery and highlighting the constraints on her personal freedom as a servant and arguing:

"Look at me! How much am I allowed to have my own will? I have to get your room ready for you—to sweep and dust, to fetch and carry. How could that degrade me if it did not degrade you to have it done for you?"

In an attempt to hurt Sergius, Louka tells him about Raina and Bluntschli. Shocked, Sergius leaves to confront Bluntschli about Raina's supposed betrayal. He challenges the other man to a duel on horseback, but Bluntschli lightheartedly pokes fun at the notion, saying:

"Oh, thank you: that’s a cavalryman’s proposal. I'm in the artillery; and I have the choice of weapons. If I go, I shall take a machine gun. And there shall be no mistake about the cartridges this time."

Raina enters and overhears the men discussing the terms of their duel. Sergius accuses her of carrying on an affair with Bluntschli, which both she and Bluntschli vehemently deny. Raina puts a stop to their plans to duel by revealing that she knows about Sergius and Louka.

Sarcastically, Raina tells Sergius that he must now duel Nicola, as he has become engaged to Louka. Sergius is shocked by this and loses his composure, worried that he will lose Louka. Raina accuses Sergius of making Louka spy on her; soon, the truth about Sergius' relationship with Louka is exposed. Bluntschli tries to mediate the couple’s argument, but the tension continues to escalate. Sergius is humiliated by the entire process and confronts Louka, who defends her love for him.

Major Petkoff, oblivious to the dramatic events, enters without his coat. He explains that Catherine is mending it because "somebody has been wearing that coat of mine: I'll swear it—somebody with bigger shoulders than mine. It's all burst open at the back."

Nicola returns with the repaired coat, and Raina removes the incriminating photograph while helping her father put it back on. She is unaware that Petkoff already discovered the picture; when he does not find it in his pocket, he questions Raina about it—and the note on the back which read: "Raina, to her Chocolate Cream Soldier—a souvenir."

Petkoff extracts confessions from everyone. Sergius admits his romantic involvement with Louka; Nicola's true role as a confidant rather than a suitor to Louka comes to light; and Raina admits to hiding Bluntschli. As the confessions unfold, Petkoff must come to terms with the complexities of the relationships around him. The once-heroic Sergius is exposed as a fallible human, and Raina's illusions are shattered.

Louka suggests that Raina marry Bluntschli, and though the Swiss captain initially rejects the idea, he changes his mind when he learns that Raina is twenty-three years old and not, as he assumed, just seventeen. Bluntschli then offers to marry Raina, to which Catherine initially objects until she learns about Bluntschli's inheritance. The play ends happily, with everyone’s secrets coming to light and being resolved.