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Answer: A probability distribution and a volatility assumption are needed to generate interest rate paths
**Explanation:** - **Option A is incorrect**: Monte Carlo simulation is actually very appropriate for securities with path-dependent cash flows, such as mortgage-backed securities or callable bonds, where future cash flows depend on the path of interest rates. - **Option B is incorrect**: While increasing the number of paths generally improves accuracy, there's a point of diminishing returns, and the model may not necessarily converge to the "fundamental value" due to model limitations and assumptions. - **Option C is correct**: Monte Carlo simulation for bond valuation requires: - A probability distribution for interest rates - Volatility assumptions to model the randomness of interest rate paths - These inputs are essential to generate multiple interest rate scenarios for valuation.
Author: LeetQuiz Editorial Team
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Which of the following statements regarding the Monte Carlo method to value bonds is most accurate?
A
It is not appropriate for securities whose cash flows are path dependent
B
The greater the number of paths, the closer the model is to the security's fundamental value
C
A probability distribution and a volatility assumption are needed to generate interest rate paths
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