Consider the risk-neutral Ho-Lee model for continuously compounded rates with a step size of A =...

 

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Consider the risk-neutral Ho-Lee model for continuously compounded rates with a step size of A = 1 year: T₁+1 = ₁ + 0₂ A+ o√À +1 where, under the risk-neutral measure, the shock 1+1, which is realized at time t+1, is given by €1+1 = S+ +1 with probability 0.5 -1 with probability 0.5 You observe the following information at time t = 0: • Volatility is o = 0.015. • The price of an one year ZCB with a face value of 100 is 98.04. • The price of a two year ZCB with a face value of 100 is 94.26. Using the above information, calibrate your interest rate tree. What is ro, 0 and r₁,+ ro + 0 ±o? = Consider the risk-neutral Ho-Lee model for continuously compounded rates with a step size of A = 1 year: T₁+1 = ₁ + 0₂ A+ o√À +1 where, under the risk-neutral measure, the shock 1+1, which is realized at time t+1, is given by €1+1 = S+ +1 with probability 0.5 -1 with probability 0.5 You observe the following information at time t = 0: • Volatility is o = 0.015. • The price of an one year ZCB with a face value of 100 is 98.04. • The price of a two year ZCB with a face value of 100 is 94.26. Using the above information, calibrate your interest rate tree. What is ro, 0 and r₁,+ ro + 0 ±o? =

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To price the cap using the HoLee model we need to calculate the present value of each cash flow and ... View the full answer