- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 27. The Arbitrage-Free Valuation Framework
- Subject 2. The Basics of Creating a Binomial Interest Rate Tree
CFA Practice Question
For a t-period binomial interest rate tree, there are ______ final payoffs.
B. 2t
C. t + 1
A. t2
B. 2t
C. t + 1
Correct Answer: C
This is because a binomial interest rate tree is recombining. An up-down movement has the same ending value as a down-up movement.
User Contributed Comments 2
| User | Comment |
|---|---|
| cfa2017 | Given current level of short-term rate r, next-period short rate can take on only two possible values: an upper value ru and a lower value rl, with equal probability of 0.5. In period 2, the short-term interest rate can take on four possible values: r uu, r ul, r lu, r ll. |
| davidt87 | cfa2017 no dude, did you even read the answer? In period 2 there are 3 final payoffs, because the upper and lower values of the period 1 payout options combine to the same middle value: 5 - 4 - 3 3 - 2 - 1 |