Lecture 3+4

Question 1

how do interest rates change over time

Answer 1

The movement of interest rates is initially stimulated by the central bank, due to the state of the economy

Question 2

how is risk evaluated when building interest rate trees

Answer 2

we describe interest rates under the risk neutral valuation
where it is assumed to be 0.5

Question 3

who is the creator of the term structure of interest rate models

Answer 3

ho and lee 1986

Question 4

define a callable bond

Answer 4

bonds that give the issuer the right to repurchase the contractual cash flows of the bond
callable bonds are cheaper and offer a higher yield
bond will be called when the continuation value is higher than the cost of calling the bond

Question 5

define a putable bond

Answer 5

bonds that give the bondholder the right under certain circumstances, to sell the bond back to the corporation
putable bonds are more expensive and offer a lower yield

Question 6

define a caplet and floorlet

Answer 6

caplet is a call option on an interest rate
floorlet is a put option on an interest rate

Question 7

what is the cap premium equal to

Answer 7

the sum of the premium for the separate caplets