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Fixed Income chapter 12:Analysis of Bonds with Embedded Options

Textbook:Bond Markets, Analysis, and Strategies, 9^th edition by Frank Fabozzi. The publisher is Pearson.

This assignment uses several of the binomial interest rate trees from Chapter 12 in your customized text and from Chapter 18 in the full, hardbound book. Use the discussions in the text to help you through these problems. Merely copying what is in the text does you no good. Work through these problems yourself, and then redo the problems using the changes described below.

1. a.) Calculate the value of the option-free bond from Exhibit 18-13.

b.) Calculate the value of this bond assuming it is callable in 1 year at par (Exhibit 18-14).

c.) Calculate the value of this bond assuming it is putable in 1 year at par (Exhibit 18-16).

Be sure you can fill in the forward interest rates for the interest rate tree, taking as given r₀, r_1,L , and r_2,LL. Where r₀ = 3.500%, r_1,L = 4.074%, and r_2,LL = 4.530%.

1. The problems above assumed that interest rate volatility was 10%. Redo the three problems above assuming that interest rate volatility is 20%.