- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 27. The Arbitrage-Free Valuation Framework
- Subject 3. Valuing an Option-Free Bond with a Binomial Tree
CFA Practice Question
Assume one year spor rate S1 is 3%, and 2 year spot rate S2 is 3.2%. Interest volatility is 20% for all the years. What is the higher rate at year 1 in the bionomial interest rate tree?
B. 4.153%
C. 5.072%
A. 3.784%
B. 4.153%
C. 5.072%
Correct Answer: B
In a binomial tree the 1 year spot rate is equal to the forward rate for the first year F0,1. Since (1 + S2)2 = (1 + F0,1) (1 + F1,2)=> 1.0322= 1.03 x (1 + F1,2) => F1,2 = 3.4%. This is the average of higher and lower interest rates. F1,2H = 0.034 e1 x σ = 0.034 e0.2 = 4.153%
User Contributed Comments 2
| User | Comment |
|---|---|
| berns23 | Shouldn't the answer be C? 5.072% i.e 0.034e*(2x0.2) |
| berns23 | Nvm..I finally got it. Page 287 is clear enough. |