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Binomial Interest Rate Options Pricing

CFA Exam, CFA Exam Level 2, Derivatives

This lesson is part 6 of 25 in the course Derivatives Part 2
  • Similar to the applications of the interest rate tree discussed in fixed income, a variation of the binomial option pricing model as presented can be used for options on bonds and interest rates.
  • The analyst will need to:
    1. Create an interest rate tree of future spot rates.
    2. Calibrate the interest rate tree so current prices for recently issued bonds are correctly priced.
    3. Value the underlying bond with the calibrated interest rate tree.
    4. Apply the decision rule for the option on each tree node; the value of the option at each node will be its intrinsic value.
    5. Calculate the option’s “fair” price by discounting the intrinsic option values through the tree.
Series Navigation‹ Call Option Price FormulaBlack-Scholes-Merton (BSM) Option Pricing Model ›
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In this Course

  • CFA Level 2: Derivatives Part 2 – Introduction
  • Introduction to Options
  • Synthetic Options and Rationale
  • One Period Binomial Option Pricing Model
  • Call Option Price Formula
  • Binomial Interest Rate Options Pricing
  • Black-Scholes-Merton (BSM) Option Pricing Model
  • Black-Scholes-Merton Model and the Greeks
  • Dynamic Delta Hedging & Gamma Related Issues
  • Estimating Volatility for Option Pricing
  • Put-Call Parity for Options on Forwards
  • Introduction to Swaps
  • Plain Vanilla Interest Rate Swap
  • Equity Swaps
  • Currency Swaps
  • Swap Pricing vs. Swap Valuing
  • Pricing and Valuing a Plain Vanilla Interest Rate Swap
  • Pricing and Valuing Currency Swaps
  • Pricing and Valuing Equity Swaps
  • Swaps as Theoretical Equivalents of Other Derivatives
  • Swaptions and their Valuation
  • Swap Credit Risk and Swap Spread
  • Interest Rate Derivatives – Caps and Floors
  • Credit Default Swaps (CDS)
  • Credit Derivative Trading Strategies

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