Question
2) Construct a binomial interest rate tree assuming conditions (i)-(v): i) the constant annual volatility of 10%, ii) probabilities for each movement are 50%, iii)
2) Construct a binomial interest rate tree assuming conditions (i)-(v): i) the constant annual volatility of 10%, ii) probabilities for each movement are 50%, iii) the log of the rate when the price goes down is one standard deviation down from the mean 1-year forward rate starting at each corresponding year, iv) the log of the rate when the price goes up is one standard deviation up from the mean 1-year forward rate starting at each corresponding year, v) the interest rates should match the forward rates. 3) Consider a bond with three months to maturity and a monthly coupon rate of 2%. Use the binomial tree above to price this bond.
The benchmark (annual pay) par curve is: Maturity Par Rate (in months) 1.10% 1.30% 1.40% 1.50% The benchmark (annual pay) par curve is: Maturity Par Rate (in months) 1.10% 1.30% 1.40% 1.50%Step by Step Solution
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