Question: (a) You are given the following binomial interest rate tree. The risk-neutral proba- bility, p* = 0.55. 12.2% 10.9% 8.0% 9.1% 7.3% 5.0% X is

(a) You are given the following binomial interest rate tree. The

(a) You are given the following binomial interest rate tree. The risk-neutral proba- bility, p* = 0.55. 12.2% 10.9% 8.0% 9.1% 7.3% 5.0% X is the present value of a 8.5% interest rate cap on a 1000 three-year loan with annual interest payments. Assuming the binomial tree gives effective annual interest rate, compounded annually, determine the value of X. (8 marks) (a) You are given the following binomial interest rate tree. The risk-neutral proba- bility, p* = 0.55. 12.2% 10.9% 8.0% 9.1% 7.3% 5.0% X is the present value of a 8.5% interest rate cap on a 1000 three-year loan with annual interest payments. Assuming the binomial tree gives effective annual interest rate, compounded annually, determine the value of X. (8 marks)

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