Bonds with Embedded Options EOC, Question 4


This question is on page 376. Given the following information: PAR RATES:

1-year - 2.250%

2-year - 2.750%

3-year - 3.100%

The binomial interest rate tree is already given in the example. I got most of the problem right but in Y0, they value the bond using a rate of 2.250, in the binomial interest rate tree exhibit they give us, Y0 is 2.5000%. Which one is right?

I thought in Year 0, spot rates = par rates = forward rates. The question mentions interest rate volatility of 10%, but I thought this only affected future rates.

Could this be a typo?

It’s in this years errata if I recall correctly. It’s an error