Reference no: EM132505006

Part -1:

1) Obtain the yields for maturity T as seen from time t_0

2) Work out the half-life and check from your graph

3) Suppose that the Expectation Hypothesis is true. If it is, what do you expect the future short rate in two years' time to be?

4) If the EH is not true, given the parameters above, would the real-world expectation of the future short rate in two years' time be higher or lower than than what you would get if the EH were true?

Part -2:

Q1 Build the interest rate tree in cells D14:F18 by building the bond-price trees in cells G6:I10 and K5:N11

You will have to search numerically for two quantities - you can use the Excel solver, or you can do it by hand
Careful: in class we assumed that dt was 1 year - here it is 0.25. This will change the expression for r_up given r_down

Q2 Why is this construction important to show that the price of a discount bond is equal to the expectation of (minus) the path of the short rate?

Q3 Is this the expectation under P or under Q? Why?

Part -3:
In column F you have the forward rates as from today for delivery (expiry) given in column E.

1) Find the prices of the discount bonds maturing at each of the maturities in column E

2) Find the continuosly compounded yields for the same discount bonds and put them in column H

3) How are the yields in column H related to the forward rates in column F?

4) Given the discount bond prices you have obtained, what is the 6-month forward rate expiring at time T=1.0 for delivery at time T=1.5?

Hint: Think of which discount bonds you would be buying and selling

Attachment:- Project.zip