1. Consider a non-callable 1.5 year, 3% coupon bond under the following interest rate tree assumption.

t=0	t=0.5	t=1
1.74%	2.90%	4.77%
	2.14%	3.52%
		2.60%

a. Can you price bond using a bond tree? Answer is in Table 11.4 on page 388.

b. Now, consider a call option written on this straight vanilla bond. The bond can be refunded at par, i.e. $100, only at . Can you price the call? Answer is in Table 12.2 Panel (B) in

page 426.

c. Now, assume that the underlying bond can be callable at par at . Can you price this

callable bond? Hint: When you issue a callable bond, in a way, you have issued a non-callable bond and bought a call option. That is, shorting a callable bond is equivalent to shorting a non-callable bond and buying a call. Since you have answers for both in (a) and (b) above, you should be able to answer this question immediately.