If an on-the-run issue for an issuer is evaluated properly using a binomial model, how would the theoretical value compare to the actual market price?
What will be an ideal response?
For an on-the-run issue that is option-free the theoretical value is identical to the bond value found when we discount at either the zero-coupon rates or the one-year forwards. Since the binomial model uses forward rates, it would be consistent with the actual market price given by the standard valuation model for an option-free bond. For example, the model uses two forward rates (a higher and lower rate each step in generating the binomial interest-rate tree) that will be consistent with the volatility assumption, the process that is assumed to generate the forward rates, and the observed market value of the bond.
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Indicate whether the statement is true or false
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Indicate whether the statement is true or false
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