On the Wiley (Elan Guide) Mocks they give you a binomial interest rate tree and want you to value a bond through backwardation. My question is when they say, “the bond is callable after two years” does that mean it’s only callable on year 3 or Year 2. Seems to stump me because I would take it as callable on year 3 and beyond. Yet they make it callable on year 2. Anyone else run into this in the wiley(elan guide) practice questions?
I always try to read carefull given details. In such case, I would consider mentioned bond as bond with embedded regular European call what means it can be executed only 2 years from now. If now is 0, this means in period 2.
My experience with CFAI material is that such details are almost always clearly stated in questions but it may not be the case with various 3rd party sources. So maybe even they mean on Bermuda style option, thus this call may execute in period 2 and period 3. Try both solutions in bond valuation backward process and you will find the answer. As I said I am quite sure that we shouldn’ guessing on real exam.
For whatever it’s worth, when I write that a bond is callable after two years, I mean the when 2 years have passed (i.e., it’s two years from the issue date), the bond can be called. You don’t have to wait till year 3.
I’d expect that the exam will make it perfectly clear; the point of the exam isn’t to confuse you about the date when the bonds can be called.