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Let the six-month interest rate be 5% semi-annual. To satisfy no-arbitrage, assume the six month rate moves up or down by 25 bp each six-month
Let the six-month interest rate be 5% semi-annual. To satisfy no-arbitrage, assume the six month rate moves up or down by 25 bp each six-month period with equal probability. Build an interest rate tree and value a two-year, 5.5% callable bond that can only be called at six-months or one-year for par ($100). What is the value of the embedded option?
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