Explain this highlighted part.
Share
Please briefly explain why you feel this question should be reported.
Please briefly explain why you feel this answer should be reported.
Please briefly explain why you feel this user should be reported.
This is very basic stuff interest rate dependent cashflows means if the interest rate increase bond price decresaes and vice versa.
In the option embedded bond the CF depends upon the interest rate, if interest rate falls callable bond is called and if interest rate rises puttable bond is put. Therefore we can’t pull option embedded on the spot rates, that’s why we go to binomial and entertain the volatility in the model.