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AssignmentThree

# AssignmentThree - ActSc 445/845 Fall 2010 Assignment 3 Due...

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ActSc 445/845 Fall 2010 Assignment 3 Due Date: November 16, 2010 (in class) Note: 445 students can work in teams of two for this assignment. No team of three is allowed. A drop-box on UW-ACE will be created where you will be asked to provide your computer files (Excel spreadsheet, R/Matlab programs, etc.) for the assignment. Further instructions on what to hand in and how to let us know who the team members are will be posted later on. 1. 6% 5% 7% 4% 6% 8% 3% 5% 7% 9% year 0 year 1 year 2 year 3 Short Rate Binomial Lattice q ( t, n ) = 0 . 5 Answer the following parts based on the above (riskless) short rate lattice: (a) Compute the implied 1-year, 2-year and 3-year spot rates. (b) Use backward recursion to price a 4-year coupon bond with 100 face value and annual coupon rate of 6% payable annually. (c) Use backward recursion to price a 2-year floor with floor rate 6% payable in advance, \$1,000 notional amount and reset annually. (d) Compute the Arrow-Debreu prices A ( t, n ) , t = 0 , . . . , 3 , n = 0 , . . . , t .

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