- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 29. The Arbitrage-Free Valuation Framework
- Subject 3. Valuing an Option-Free Bond with a Binomial Tree

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**CFA Practice Question**

Assume in a 2-period binomial interest rate tree, the two nodes to the right of N are N

B. N

C. N

_{H}and N_{L}, and the two nodes to the right of N_{H}are N_{HH}and N_{HL}, and the two nodes to the right of N_{L}are N_{LH}and N_{LL}. The backward induction methodology says to determine the value at N_{H}, we need to know the values at:A. N

_{L}and NB. N

_{HH}and N_{HL}C. N

_{LH}and N_{LL}Correct Answer: B

Backward induction is the process of valuing a bond using a binomial interest rate tree.

"Backward" because in order to determine the value of a bond at Node 0, you need to know the possible values of the bond at later future nodes.

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