You get to build the interest rate tree based on the rate curve and the interest rate
Question:
You get to build the interest rate tree based on the rate curve and the interest rate volatility of 15%. Follow the iterative procedure as described in the text. Remember that the possible rates in every period are separated by a factor of e^(2*sigma). For every period, take a guess for what the lowest rate might be, and compute the rest of them based on volatility. Then calculate the price of the same-maturity par bond based on these rates, in the workspace trees set up to the right. Use goal seek to tweak the rate until the price of the par bond is exactly 100 using the tree. Then move on to the next par bond, etc. until you fill in the entire rate tree. At the end, you should have a tree of interest rates that prices each par bond at exactly 100.
Financial Institutions Management A Risk Management Approach
ISBN: 978-0071051590
8th edition
Authors: Marcia Cornett, Patricia McGraw, Anthony Saunders