Last minute binomial tree confusion

I’m so confused with the binomial tree, sometimes the par plus coupon should be discounted from the last period, sometimes it skips the last period and only discount for n-1 periods. I’m sure I understand this terribly wrong because seems like no one else has the same trouble…

If you’re referring to Q40 on the CFA Level II 2017 Mock PM exam, then you’re not alone

The question asks for a 3-year coupon bond, so you should start discounting from “Year 2” in the question.

Generally, you should NOT skip the last period and should discount all periods with par plus coupon. Only in Year 1 do you not add or plus coupons.

I just solved the mock and have the same confusion.

Here is the problems

Mock - afternoon problem 40

(Please click on the link if the image doesnt appear)

Just like tingli mentioned above, why is the coupon 2.8 taken again after considering 102.8 ?

Also, why is the period n-1?

Any help is appreciated

Thanks yx5353.

But why add 2.8 over and above the 102.8 which includes the par of 100 + 2.8 coupon?

Ive not come across such a thing in schweser.

An elaborate explanation would be more helpful.

Thanks

This is similar to how you would approach any binomal tree valuation for risk-free bonds

Usually the coupon is taken again in all time periods (except Year 1 or time 0) because the value at that time includes the coupon payment

In this example, the coupon 2.8 is taken again after discounting and considering 102.8, along with the other nodes. The only time coupon 2.8 is not taken again is at time 0, when no coupon is paid.

Hope that helps

Thank you for the clarification. So a good way to avoid mistake might be to check if the binomial tree starts with Year 0. After all, N periods binomial tree should be discounted for N times.

It is confusing the way the answer is structured, but the 2.8 coupon are from two different nodes (makes it looks like added twice). If you try to do it your own way, you will reach the same result.

Understood the yearly naming part, but still have my doubts about the coupon.

Have a look at this.

This is from schweser. A similar 3 year bond. This does not add the coupon (3) over and above the 103 (100 + 3 coupon)

Schweser FI

After discounting for the first time (as shown in your picture), you will need to add the coupon before discounting another time. The mock simply displayed these two steps together, not actually adding coupon twice a node as you might be thinking. You will only need to add coupon once every node no matter what. I hope this doesn’t confuse you more. Try calculate yourself, your answer should be the same as the mock.

Hi sidesh, the reason you add 2.8 over the 102.8 (which already includes the par 100 + 2.8 coupon) is because you’re adding 2.8 to the DISCOUNTED 102.8

More specifically, you’re adding 2.8 to 102.8/1.0456, which is the discounted 102.8

Yes I got it confused initially as well

Like you said, a good way to remember is that a N period bond should be discounted N times on the binomial tree.

Tried solving it. Got the correct answer. Thanks a ton. Good luck :))