hey guys,
so in the binomial pricing chapter of fixed income, the Schweser material adds back coupon payment in order to reach value at T0 whereas the curriculum doesn’t.
would appreciate some clarity on this.
Thanks !
They both do.
Reread them carefully.
This is the same issue I am having. Bill, I replied to you in another thread about this. If you could see that we would appreciate it. Thanks.
What do yo u mean “adds back” coupon payment? The coupon is added at each leg of the tree.
I went and looked into what he was saying. When solving for each node, you add in the coupon payment and then discount the value of the bond backwards by the discount rate. Once you get that value, you keep doing it until you get to the value at T=0… He’s confused about why it wasn’t added in like you do when you keep solving for values at each node.
I just replied there.
The question is whether you want the value of the bond at a particular node, or the value of the bond together with the coupon payment. To value the bond today, you will add the coupon payment at each node. However, to decide whether an embedded option will be exercised at a particular node, you want the value of the bond without the coupon payment, as the decision will be based only on the value of the bond (because the coupon is paid whether the option is exercised or not; hence, it is irrelevant to the decision).
Ok great, thanks. So if we are looking at T=0 value, we are including all of the future coupon payments at each node. But if we are looking at 1 specific node at time other than 0, we don’t include the coupon of that specific node in the value of the bond at the specific node.
You got it.