Pricing a noncallable 6% semi-annual pay bond here, interest rate tree (given as bond equivalent yields): 1.5 years = 7.91% 2.0 years (up state) = 8.95% 2.0 years (down state) = 7.23% Binomial price tree: 1.5 years = ?? 2.0 years (up state) = 91.73 2.0 years (down state) = 96.17 So the value at the 1.5 years point, is: [(0.5 x (91.73 + 3)) + (0.5 x (96.17 + 3))] / (1 + (0.0791 / 2) ) For the denominator in bold, why do we need to divide it by 2, isn’t the interest rate already given as a half year period?
Is the 1.5 year rate of 7.91% annualized? If so, you are finding PV of the expected 2 year bond value at 1.5 - half a year, hence devide by 2.
Okay got it. The 7.91% is a bond equivalent yield, so yeah it’s annualised. Thanks