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Problem 9. Use the term structure lattice model (from t = 0 to t = 3) below to price the bond derivatives in the

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Problem 9. Use the term structure lattice model (from t = 0 to t = 3) below to price the bond derivatives in the following questions. 11.72% 9.38% 8.44% 7.5% 6.75% 6.08% P 6.0% 5.4% (1-p) 4.86% 4.37% The upper probability is: 3 p = 0.5 (a) Compute P32, which is the state price of the elementary security (or the Arrow-Debreu security), paying 1 dollar at time 3 and state 2: refer to the node with interest rate 8.44% on the graph. (Round your answer to the fourth decimal place.) (b) Consider a forward-start swap, starting at time t = 1 and ending at time t = 3. Notional principal is 100,000. Fixed rate of swap is 7% Payments at t = i for i = 2, 3 are based as usual on fixed rate minus floating rate that prevail at ti 1 What is the value of the swap at t = 0?

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