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Note: please assume annual compounding of interest for these problems.
The on-the-run US Treasury par curve is as follows:
Maturity Coupon/YTM Market Price
1 3.50% $100
2 3.75% $100
3 4.00% $100
Using the bootstrapping methodology, the spot rates are:
Maturity Spot Rate
1 3.5000%
2 3.7547%
3 4.0134%
Assume 10% annual interest rate volatility
1. Calculate the binomial interest rate tree using the 2-year on-the-run issue and the 3-year on-the-run issue.
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