CFA Level II 2017 Mock Exam PM - Q37 Binomial Interest Rate Tree

Can someone help explain Q37 in the CFA Level II 2017 Mock Exam PM?

Why is Fujioka incorrect about the calibration of the interest rate trees? To calibrate the binomial tree, you would have to make sure 2^n interest rate nodes are adjusted. Given that sheer amount of size, wouldn’t a complicated software be needed? The answer suggests that one could just use EXCEL Solver.

I’ve never personally performed a “calibration” of interest rate trees. Has anyone done it before? If so, can someone shed light on this?

at first try, I also answered this. I just learned to accept that maybe binomial tree construction is as simple as CFAI asserts. let’s not argue with CFAI.

edit: what CFAI seems to suggests is that, using the current market bond prices, one can use excel solver to determine the appropriate interest rates in the tree.

ok thanks Edbert you’ve been great

with a recombining tree its n+1 not 2^n i think

ah ok i see what you mean

with a recombining tree it’s 1 + 2 + … + n = n(n - 1)/2 ~~ so should be around n^2, which I guess you can do with EXCEL Solver

I’ve built and calibrated many binomial interest rate trees in Excel using Solver. It’s pretty slick.