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You want to build a simple 2-date interest-rate tree to price a caplet. Each period is 6 months long. The current 6m rate is r(0,6m)=4.5%,
You want to build a simple 2-date interest-rate tree to price a caplet. Each period is 6 months long. The current 6m rate is r(0,6m)=4.5%, with semi-annual compounding, and you choose the two possible values in 6 months to be 5.0%, respectively 4.0%. Finally, the current 1-year rate is r(0.1y)=4.5% (also s.a. compounding). What is the risk-neutral probability for the outcome 5.0%
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