A bond with a 12% annual coupon will mature in two years at par value. The current one-year spot rate is 14%. For the second year, the yield volatility model forecasts a lower bound of 12% for the one-year rate and a standard deviation of 10%. In a binomial interest rate tree describing this situation, what are the forecasted values for the bond in the first nodal period?
(112)/[1+0.12*e^(0.20)] = 97.68279567 ??? EDIT: Gotta love that subject line.
This is one of those questions that I thank God that the test is multiple choice. I’m not even sure what the fugg they’re asking. So the answer’s “b”.
skillionaire Wrote: ------------------------------------------------------- > This is one of those questions that I thank God > that the test is multiple choice. > > I’m not even sure what the fugg they’re asking. > > So the answer’s “b”. That is what I am going to do. B
I agree Skillinaire. swaptiongamma – nice job The value of the bond for the lower rate is easy; since that forecasted rate is the coupon rate: V1,L = 100. The value for the upper rate will be determined by the lower rate and the standard deviation: i1,U = i1,L × (e2 × s) = 0.12 × (e0.20) = 0.14657. Thus, V1,U = (112 / 1.14657) = 97.683.
So the common consensus is to choose B??? I was thinking C as my safe haven…
swaptiongamma Wrote: ------------------------------------------------------- > So the common consensus is to choose B??? I was > thinking C as my safe haven… not for you Mr. Curve Setter
I went with “b” last year and I’m back again.
haha planner. I am back again too. Last time, there were 4 options and now we have three. Basically, it all depends on luck!
I chose B on atleast 12 questions last year. Here I am back again.
Okay. I’ve decided to stay away from “b” on my guesses! That’s the end of that… I’ll go with “c” for “Hope to never c ya again L2.”
swaptiongamma Wrote: ------------------------------------------------------- > (112)/[1+0.12*e^(0.20)] = 97.68279567 ??? > swap/planner - can you guys help me understand the denominator? I know planner did it before but I don’t get it. Don’t we have to discount it at the current rate of the one yr spot rate (i.e. 14%)?
Would one of you be a sport and explain to me where the “.2” comes from? Basically, I’m not getting this: “i1,U = i1,L × (e2 × s) = 0.12 × (e0.20) = 0.14657” I understand that the 14.657% is the upper rate that you derived, and I understand that you’re using the lower forecasted rate of 12% and the standard deviation of 10% to get that rate, but the “e2” and the “e0.20” are leaving me somewhat befuddled. If no one wants to help, I’m sticking with “b”.
you double the S. So, 2 x the standard dev of .10 = e.20
So basically it’s the lower bound multiplied by (e^(2S)), correct?
Interest Rate in the upper node = (Interest rate in the lower node)* e^(2 * standard deviation) But I don’t know if this is there for L2, this year?
I don’t remember seeing it, although in all honesty that’s about 40% of the curriculum.
Can we confirm if this is in the curriculum? I can’t find it
It looked foreign to me as well.
It’s in Schweser’s warm-up (just noticed), but I can’t find it in the CFAI books. Anyone else?