Recall from the chapter that each node is represented by both a time element and a rate

Question:

Recall from the chapter that each node is represented by both a time element and a rate change component. Which of the following statements about the missing data in Exhibit 3 is correct?

A. Node 3–2 can be derived from Node 2–2.

B. Node 4–1 should be equal to Node 4–5 multiplied by e^0.4.

C. Node 2–2 approximates the implied one-year forward rate two years from now.

Katrina Black, a portfolio manager at Coral Bond Management, Ltd., is conducting a training session with Alex Sun, a junior analyst in the fixed-income department. Black wants to explain to Sun the arbitrage-free valuation framework used by the firm. Black presents Sun with Exhibit 1, showing a fictitious bond being traded on three exchanges, and asks Sun to identify the arbitrage opportunity of the bond. Sun agrees to ignore transaction costs in his analysis. EXHIBIT 1 Three-Year, 100 par, 3.00% Coupon, Annual Pay Option-Free Bond Eurex NYSE Euronext 103.7956

Black shows Sun some exhibits that were part of a recent presentation. Exhibit 3 presents most of the data of a binomial lognormal interest rate tree fit to the yield curve shown in Exhibit 2. Exhibit 4 presents most of the data of the implied values for a four-year, option-free, annual pay bond with a 2.5% coupon based on the information in Exhibit 3. EXHIBIT 2 Yield-to-Maturity Par Rates for One-, Two-, and Three-Year Annual Pay Option-Free Bonds One-year

EXHIBIT 3 Binomial Interest Rate Tree Fit to the Yield Curve (Volatility = 10%) Time 0 Time 1 Time 2 Time 3

EXHIBIT 4 Implied Values (in Euros) for a 2.5%, Four-Year, Option-Free, Annual Pay Bond Based on Exhibit 3

Black asks about the missing data in Exhibits 3 and 4 and directs Sun to complete the following tasks related to those exhibits: Task 1 Task 2 Task 3 Task 4 Test that the binomial interest tree has been properly calibrated to be arbitrage