bdt (Excel)

							                                   3b4a89d3-607a-4750-a758-1c030d22a6b8.xls


How to Solve the Black-Derman-Toy tree:
1. Set the one year interest rate equal to the yield on a one-year bond
2. Using Solver, set the two rates in the binomial tree at one year to make the 2 yr. bond
    YTM and Yield Volatility for the model equal to the Actual Values:
3. Using Solver, set the upper two rates in the binomial tree at two year to make the 3 yr. bond
    YTM and Yield Volatility for the model equal to the Actual Values:
4. Using Solver, set the upper two rates in the binomial tree at three years to make the 4 yr. bond
    YTM and Yield Volatility for the model equal to the Actual Values:
5. Now, this interest rate tree can be used to price bond options. Remember than the risk neutral
     Probability of an up-move is 1/2.

Interest Rate Tree:                    Zero Coupon Yields & Volatilities
                          10.30%       Model Values:                  Actual Values:
                  9.60%                       YTM Vol
                                       Maturity                       Maturity YTM         Volat
         6.67%            8.67%             1 4.00% N/A                       1 4.00%      12.00%
4.00%             7.97%                     2 5.00% 11.00%                    2 5.00%      11.00%
         5.35%            7.29%             3 6.00% 10.00%                    3 6.00%      10.00%
                  6.63%                     4 6.50% 9.50%                     4 6.50%       9.50%
                          6.14%

Zero Prices:                           YTM Trees:

One Year:
              1
 0.962                                 4.00%
              1

Two Year:                              Two Year:
                      1
         0.937                                 6.67%
 0.907                1                5.00%
         0.949                                 5.35%
                      1

Three Year:                            Three Year:
                               1
                  0.912                                 9.60%
         0.862                 1               7.72%
  0.84            0.926                6.00%            7.97%
         0.885                 1               6.32%
                  0.938                                 6.63%
                               1

Four Year:                             Four Year:
                                   1
                          0.9066                                ######
                  0.833            1                    9.54%
         0.793            0.9202               8.05%            8.67%
 0.777            0.858            1   6.50%            7.98%
         0.824             0.932               6.66%            7.29%
                  0.879            1                    6.67%
                          0.9422                                6.14%


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