Construct a trinomial tree for the Ho-Lee model where = 0.02. Suppose that the the initial zero-coupon interest rate for a maturities of 0.5, 1.0, and 1.5 years are 7.5%, 8%, and 8.5%. Use two time steps, each 6 months long. Calculate the value of a zero-coupon bond with a face value of $100 and a remaining life of 6 months at the ends of the final nodes of the tree. Use the tree to value a 1-year European put option with a strike price of 95 on the bond. Compare the price given by your tree with the analytic price given by DerivaGem.

AppendixLO1