Binomial Interest Rate Trees and the Valuation of Bonds with Embedded Options

Apr 18, 2013

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Binomial Interest Rate Tree . The inclusion of option features in a bond contract makes the evaluation of such bonds more difficult. A 10-year, 10% callable bond issued when interest rate are relatively high may be more like a 3-year bond given that a likely interest rate decrease would lead the issuer to buy the bond back. Determining the value of such a bond requires taking into account not only the value of the bond's cash flow, but also the value of the call option embedded in the bond21

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Binomial Interest Rate Trees and the Valuation of Bonds with Embedded Options

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