Let T be the total amount of time to be modeled with the tree, and h be
Question:
Let T be the total amount of time to be modeled with the tree, and h be the length
of time between each time period on the tree. Assuming the following parameter
values: 0r0,.25 = 6.5%, h = .25, T = .5, ? = 8.0%, ? = 2.5%, ? = .70, and ? = 0.20,
the following tree emerges.
(graph)
At each node the first number is the yield on a zero coupon bond with a 3 month
maturity; the second number (when present) is the yield on a zero coupon bond
with a 6 month maturity; and the third number (when present) is the yield on a
zero coupon bond with a 9 month maturity. For example, 0r0,.75 is the yield of a 9
month zero coupon bond, i.e. covering time 0 to .75 years from now, observed
today. All the yields are annualized with continuous compounding. Can you find
the three missing values?
Aside: Inferring yields of long-term bonds from a tree is an important exercise, in
particular if investors require a risk premium. A step-by-step description about
how to solve for the term structure given such a tree can also be found in the
technical notes, pages 703 - 715.
Data Analysis and Decision Making
ISBN: 978-0538476126
4th edition
Authors: Christian Albright, Wayne Winston, Christopher Zappe