Binomial Interst Rate Tree - Schweser Mock Q42

CFA Level II Fixed Income
#1

Hi guys,

In Schweser’s Mock there’s a question that asks to calculate the value of a bond with the following information.

Maturity: 3 years

Option: Callable at par in 1 year

Coupon: 2%

Par value $100

The interest rate tree is

Year 0 = 1.5%

Year 1, upper node = 2.8873%

Year 1, lower node = 1.9354%

Year 2, upper node = 4.1328%

Year 2, middle node = 2.7703%

Year 2, lower node = 1.8570%

The value I get for the lower node in year 2 is $100.14 (obtained from 102/1.01857) so since the value is higher than par, I believe it should be called and so the value should be $100, but according to the answer it is not. The answer simply uses $100.14.

Could you please tell me why??

Thanks!!

#2

Is it possibly callable only after 1 year but not after 2?

Otherwise, it’s weird.

#3

Generally, is this the case? I thought when it says callable in 1 year it means it’s callable any time after year 1.

#4

That’s the usual case.

I’m simply trying to think of a scenario that doesn’t boil down to them having fouled it up.

#5

Hmm, ok, thank you!

#6

Option: Callable at par in 1 year : This solves your assumed big problem clearly the Bond is not Callabe at T=2 now because in all the examples you have been doing in Schweser the bonds where being called at T=1 and T=2 then you rushed to what stuck into your head during practice without necessarily paying attention to the question. On the exam day the answer for your method will be one of the answer options and you will get out of the exam feeling confident. Please read the question carefully.

#7

The definition of the call is ambiguous. I would expect the official exam to be more clear.

#8

Where, again, did you get your psychology degree? I’ve forgotten.

#9

Where, again, did you earn your psychology degree? I’ve forgotten.