Question #15
Reading: Reading 26 The Arbitrage-Free Valuation Framework
PDF File: Reading 26 The Arbitrage-Free Valuation Framework.pdf
Page: 7
Status: Correct
Correct Answer: B
Question
With respect to interest rate models, backward induction refers to determining:
Answer Choices:
A. convexity from duration
B. the current value of a bond based on possible final values of the bond
C. one portion of the yield curve from another portion
Explanation
Backward induction refers to the process of valuing a bond using a binomial interest rate
tree. For a bond that has N compounding periods, the current value of the bond is
determined by computing the bond's possible values at period N and working
"backwards."