# Interest Rate Trees

I have no clue on how to get the arbitrage free price for a bond with enbedded option by backward indution, I look @ the book and I can’t figure how they move from right to left, how do you figure the rate @ each node??? Thanks

rate at each node will be GIVEN to you. you are not expected to know how those rates come by.

cpk123 Wrote: ------------------------------------------------------- > rate at each node will be GIVEN to you. > > you are not expected to know how those rates come > by. Correct. In the exam, you will be given the binomial interest rate tree. The CFAI book does mention the methodology to produce the interest tree with example to help show the actual calculation

I was having trouble with this too. one more Q. When we speak of interest rate volatility regarding the tree what exactly are we talking about? I mean the assumtion of int rate volatility.

epoh Wrote: ------------------------------------------------------- > I was having trouble with this too. one more Q. > When we speak of interest rate volatility > regarding the tree what exactly are we talking > about? I mean the assumtion of int rate > volatility. Right. Specifically, the upper node’s value = low node value* exp (2* volatility) If we assume volatility = 10%, upper node’s value = low node value* exp (2* 10%) for all nodes. You can find the implicit volatility for a given tree by using above mentioned formula.

just use Schweser. They explained it me in 2 PAGES. While CFAI is trying to explain it in a TEN PAGES with no effect.