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KIC000011 - Valuation Modellcontinuedl Constructing the...

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Valuation Modellcontinuedl .:. Constructing the Binomial Interest-Rate Tree ...... Stefl 4: Calculate the ~verege preseni value of the two cash flows in step 3 This is Ihe value at a node is !. [Y J! + C + V , + C ] 2 1 + ,. I + ,. ~ Slep 5: Compare tile value in step 4 Wi~l the [mild's market valuc. If the rw<l value, are the same, the r, used in this trial is the one we seek. This is the one-yell' fOrWll.!drate thai would be u~ed ;n tile binomial interest-rate lrce fur the lower rate, and the ccrrespcnding rate would be for the higher rate If, instead, the value found in step 4 is not equal to the markel value of the bond, tnil means that the value', in this LJial is not the one-period for .... 'ard rate thai is consistent wjtb (II the volatility assumption of 10%, (2) tbe process aUW1>ed [0 generate the one-year forward rate, and (3) the observed marl:ct value nfthe bond. In this CIlS" Ihe five sleps arc repeated with a different value for r l [Ncte.Hwe gel a value 1<:S5 than $100, then lhe value for r l is
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