= 0.997
1
We now use
h(u ) =
1
+ (1 ) u
and
h * (u ) = u h(u )
For example,
h(1) =
1
= 1.0015
0.5 + 0.5(0.997)
1
1.0015
0.9985
2
3
4
5
1.0030 1.00451 1.00601 1.00751
0.9970 0.99549 0.99399 0.99249
We then use
Bi +1 (n + 1, u + n + 1) =
Bi (n, u + n + 1)
h(u )
Bi (n, n + 1)
and
Bi (n + 1, u + n + 1) =
Bi (n, u + n + 1)
h * (u )
Bi (n, n + 1)
to get (starting from the initial term structure on the first line):
u
B (0,u)
1
0.98260
2
3
0.96510 0.94740
4
0.92960
B0 (1,1+u)
B1 (1,1+u)
0.98071
0.98367
0.96128 0.94180
0.96707 0.95032
0.92247
0.93362
B0 (2,2+u)
B1 (2,2+u)
B2 (2,2+u)
B0 (3,3+u)
B1 (3,3+u)
B2 (3,3+u)
B3 (3,3+u)
0.97679
0.97973
0.98268
0.98563
B0 (4,4+u)
B1 (4,4+u)
B2 (4,4+u)
B3 (4,4+u)
B4 (4,4+u)
0.97506
0.97800
0.98094
0.98389
0.98685
5
0.9119
0.95387
0.95961
0.96540
0.97122
0.98367 =
0.9651
1.0015
0.9826
0.98071 =
0.9651
0.9985
0.9826
0.00
0.24
0.75
0.00
0.00 = (980-980.94)+
0.48
1.29
0.98
2.00 = (980-978.00)+
2.14
3.41
4.94 = (980-975.06)+
Finally, we get
P (0) = 0.7471 0.75