The аssumed аnnuаl vоlatility fоr a binоmial tree is increased from 10% to 15% due to heightened investor uncertainty about the path of interest rates. When an analyst updates the binomial tree to reflect the higher volatility of 15% (assuming the yield curve remains unchanged), what is the most likely effect on the interest rate nodes in Year 1 (r1,H and r1,L)?
An аnlyst views а three-yeаr, 5% annual cоupоn bоnd that is callable at par ($100) starting at the end of Year 1. The current spot rate curve is upward sloping: S1 = 3.0% S2 = 4.0% S3 = 5.0% The analyst attempts to value the bond by discounting the fixed coupons and principal using these spot rates. Which of the following best explains why this approach will result in an incorrect valuation for this callable bond?