LV = 0THE ADJACENT NODES IN THE BINOMIAL TREE FOR ANY NODAL PERIOD A...

1,L

V

=

0

The adjacent nodes in the binomial tree for any nodal period are all two standard deviations apart.

Question #35 of 38

Question ID: 463773

Which of the following is the appropriate "nodal decision" within the backward induction methodology of the interest tree framework for a

putable bond?

ᅞ

A)

Max(par value, discounted value).

ᅚ

B)

Max(put price, discounted value).

ᅞ

C)

Min(put value, discounted value).

Explanation

When valuing a putable bond using the backward induction methodology, the relevant cash flow to use at each nodal period is the coupon

to be received during that nodal period plus the computed value or exercise price, whichever is greater.

Question #36 of 38

Question ID: 472598

Government par curve is provided below:

Maturity (years)

Par rate

1

5.0%

2

6.0%

3

6.5%

4

7.0%

The value of a 4-year, 5% annual pay, $100 par government bond is closest to:

$101.12

ᅞ

B)

$98.49

ᅚ

C)

$93.15

Answer: First we compute the spot rates:

S

: (given) = 5%

1

S

: 100 =

+6.03%

2

S

: 100 =

3

4

Then we use the spot rates to value the 4-year, 5% annual pay bond:

Value =

Question #37 of 38

Question ID: 472605

Sam Roit, CFA, has collected the following information on the par rate curve, spot rates, and forward rates to generate a

binomial interest rate tree consistent with this data.

Maturity

Par Rate

Spot Rate

1

5%

5.000%

2

6%

6.030%

3

7%

7.097%

The binomial tree generated is shown below (one year forward rates) assuming a volatility level of 10%:

0

1

2

5%

7.7099%

C

A

9.2625%

B

Riot also generated another tree using the same spot rates but this time assuming a volatility level of 20% as shown below:

5%

8.9480%

13.8180%