1. The on-the-run issue for the Net Company is shown below along with the spot rates (assume annual compounding):

Maturity (years)	YTM%	Market price	Spot rate%
1	7.5	100	7.500
2	7.6	100	7.604
3	7.7	100	7.710

Assuming an interest rate volatility of 10% for the 1-year rate, the binomial interest rate tree for valuing a bond with a maturity of up to three years is shown below:

		9.603%
	8.481%
7.500%		7.862%
	6.944%
		6.437%

a. Using the binomial tree, determine the value of an 8.5% 3-year option-free bond. b. Suppose that the 3-year 8.5% coupon issue is callable starting in Year 1 at a call price of 100 (par). Also assume that the following call rule is used: if the price exceeds 100 the issue will be called. What is the value of this 3-year 8.5% coupon callable issue? c. What is the value of the embedded call option for the 3-year 8.5% coupon callable issue? d. If 1-year interest rate volatility is expected to be 20%, what is the value of the 3-year, 8.5% coupon callable bond? What is the value of its embedded call option?