I hate to resurrect this issue but I don’t happen to reconcile the two methods in the below referenced post (Q4 Reading 36):
https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91340274
Here is an example from Wiley:
Benchmark par curve:
Maturity Par Bond Price One-Year Spot Rate
1 1% 100 1.000%
2 1.2 100 1.21%
3 1.25 100 1.251
4 1.4 100 1.404
5 1.8 100 1.819
We start with a value of 1.1943% for r1,L. Given our interest rate model (rH = rL e2σ) and interest rate volatility assumption (σ = 15%), we obtain a value of 1.6121% (= 1.1943% × e2×0.15) for r1,H.
Using this following equation we can find the Values of the bond at particular nodes:
V=1/2*(VHHL+C/(1+r2,HL)+VHLL+C/1+r2,HL)
V1,H = 1/2*(100+1.20/(1+0.016121) + 100+1.20/(1+0.016121)=$99.59444
V1,L = 1/2*(100+1.20/(1+0.011943) +100+1.20/(1+0.011943)=$100.0056
V0 = 1/2*(99.59444+1.20/(1+0.01) + 100.0056+1.20/(1+0.01)=$100
Looking at this CFAI’s approach, it makes more sense as the current coupon does not need to be discounted. Wiley’s approach seems to differ as it does not add the coupon at the end. Anyone else confused by this?