EFFECTIVE DUR CALC PROB : Valuation and Analysis of Bonds with Embedded Options

CFA Level II Fixed Income
#1

In Reading 30 Valuation and Analysis of Bonds with Embedded Options, EOC 28.

  1. Based on Exhibits 1 and 2, the effective duration for the AI bond is closest to:
    A 1.98.
    B 2.15.
    C 2.73.

Can some one please explain to me how in the solution they changed the interest rates in the binomial tree for 30bps up/down?

VAL PROB
VAL PROB858×1612 83.5 KB

#2

You have to calibrate each new tree based on the new (up/down) par curve.

You won’t have to do that on the exam.

#3

I know this answer is late, I hope you cleared the test by now but let me save some time for others as I just figured out that the thing is that the provided trees are for the benchmark yet it was mentioned in the original question that this bond is trading at OAS of 13.95 pbs so these were added to each node so you can solve for the bond value, good luck

1 Like
#4

I recently encountered this question and figured it out myself… OAS should be added to each node to reflect the value in the option, which brings down the price (since OAS is added to the denominator). Hope this helps.