question archive 1)Given an initial spot rate for one period of 12%, a two-period spot rate of 14%, and a volatility of 5% for the spot rate over a period, what should the two possible values of the spot rate be after one period? (Assume the BDT model applies
1)Given an initial spot rate for one period of 12%, a two-period spot rate of 14%, and a volatility of 5% for the spot rate over a period, what should the two possible values of the spot rate be after one period? (Assume the BDT model applies
Subject:Mechanical EngineeringPrice: Bought3
1)Given an initial spot rate for one period of 12%, a two-period
spot rate of 14%, and a volatility of 5% for the spot rate over a period, what
should the two possible values of the spot rate be after one period? (Assume
the BDT model applies.)
2). Assume the same parameters as in the previous question, but change
the method of discounting from linear to exponential, i.e., assume that
discounting is on a continuous basis. Rework the problem and assess the impact
on the solution.
3). Suggest two alternate volatility functions for the BDT model
that do not impact any of the essential features of the model. Your answer will
demonstrate that the model is not speci cally tied to the volatility function
provided in the original model by Black, Derman, and Toy.
4). Explain what happens to (a) feasibility and (b) computational
burden as the number of periods in the BDT tree increases.
5).
Is it possible to have a bond price of value zero on the HL tree?
Answer: No, as long as the initial bond
prices are greater than zero, and h(T ); h (T ) > 0; 8T , the bond price can
never become zero.
