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Mack identifies a mispriced Mexican bond, Bond K, a three-year bond. It is an annual-pay bond with a coupon rate of 6%. To calculate the

Mack identifies a mispriced Mexican bond, Bond K, a three-year bond. It is an annual-pay bond with a coupon rate of 6%. To calculate the bonds value, Mack devises the first three years of the interest rate lognormal tree presented in Exhibit 4 using historical interest rate volatility data. Mack considers how this data would change if implied volatility, which is higher than historical volatility, were used instead.

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Based on Exhibit 4 and using a binomial interest rate tree, what is the correct price for Bond K?

EXHIBIT 4 Interest Rate Tree; Forward Rates Based on Swiss Market Year 3 6% 5% 3% Year 1 Year 4% 1% 2%

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