Question #78
Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers
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Question
An analyst has constructed an interest rate tree for an on-the-run Treasury security. The analyst now wishes to use the tree to calculate the duration of the Treasury security. The usual way to do this is to estimate the changes in the bond's price associated with a:
Answer Choices:
A. parallel shift up and down of the forward rates implied by the binomial model
B. shift up and down in the current one-year spot rate all else held constant
C. parallel shift up and down of the yield curve. Explanation The usual method is to apply parallel shifts to the yield curve, use those curves to compute new sets of forward rates, and then enter each set of rates into the interest rate tree. The resulting volatility of the present value of the bond is the measure of effective duration. (Module 27.5, LOS 27.i)
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