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Nothing

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Submitted By cacacole
Words 283
Pages 2
V = 100
C = 4
V = 100
C = 4
Ex: P 382 VH = 104 / (1+.05496) = 98.582

σ = 10%
Price = 100
VH = 98.582
C = 4
R1H = 5.496% = 1-year forward rate in the next year.
VH = 98.582
C = 4
R1H = 5.496% = 1-year forward rate in the next year.
Coupon = 4%
2-year bond

V = 100
C =4
V = 100
C =4

Vo = 99.567
C = 0
Ro = 3.5%
Vo = 99.567
C = 0
Ro = 3.5%

*In the binomial model we are taking interest rate volatility into account.
98.582 + 4 = 102.582
Vo = (102.582/1.035) + (103.522/1.035) / 2 = 99.567
V = 100
C = 4
V = 100
C = 4

VL = 104 / (1+.045) = 99.522
V = 100
C = 4
V = 100
C = 4
Ro = 1- year spot rate =
VL = 99.522
C = 4
R1L = 4.5% (initial guess) = 1-year forward rate in the 2nd year.
VL = 99.522
C = 4
R1L = 4.5% (initial guess) = 1-year forward rate in the 2nd year.
1-Year forward rate today

R1H = R1L * e2σ
= 4.5% * e2(.10) = 5.496%

Price ≠ Vo; this means the R1L interest rate we selected is too high.

There is a slight difference in finding the value of a callable bond when compared to non-callable bonds. *At any node whenever the price you find is greater than the call price we assume that the bond will be called and the call price will be paid. The price of the bond cannot exceed the call price.
If this was a putable bond then if the price of the bond fell below the put price we insert the put price.

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