CFAI L2 - Reading 37, BB Ex. 5, Quesiton 2

CFA Level II Fixed Income
#1

Hi All,

I am stuck on this problem. It gives a binomial interest rate tree for a 3-yr, annual cpn bond currently priced at 101.325 % of par and asks to find the coupon payment. How am I supposed to find the cpn pmt for this bond given the interest rate tree and voltility?

Thanks,

#2

Question 2 tells you that the price of Bond Y is 101.325, what you could do is plug each of the coupon rates given at the answer section and create a binomial interest rate to see if the Year 0 will equal to 101.325. I know this isn’t efficient in terms of timing but that how I solved it.

#3

Thanks Monkey but I think the goal is to figure it out without having the answer already lol

#4

I meant the coupon rates on the multiple choices. Let me know if you find an easier way!

#5

101.325 = [(PUp+Cpn)/(1+UpRate/200) + (PDown+Cpn)/(1+DownRate/200)] / 2

PUp, UpRate, PDown, DownRate are all known. CPN is the only unknown.

You should be able to solve for it.

#6

Hi CPK, how do we calculate the PUp and PDown in this scenario? Thanks

#7

That’s better.

If you get a price of 101.325, then the answer is B.

If you get a price higher than 101.325, then the answer is A.

If you get a price lower than 101.325, then the answer is C.

#8

It’s a binomial interest rate tree: the up and down weights are always 50%.

You’re welcome.

#9

You don’t have to be able to solve for it; the correct answer is given in one of the choices, all you have to do is select the correct one.

#10

Bottom Up Approach…:slight_smile:

#11

Hello,

It seems this problems is trial and error using the interest rate tree.

Do these types of problems exist on the exam? Where the ONLY way to get the correct answer (besides guessing) is doing trial and error among the choices given.

#12

Thanks magician!

#13

My pleasure.