Explanation

The correct answer is D because:

• Ho-Lee model is an additive model where the drift terms are additive. In the Ho-Lee model, the short rate follows an arithmetic Brownian motion process with additive drift.

• Lognormal model (such as Black-Karasinski or Black-Derman-Toy models) has multiplicative drift terms. In lognormal models, the short rate follows a geometric Brownian motion process where the drift term multiplies the current level of the rate.

Key Differences:

• Ho-Lee Model: Additive drift - r(t+Δt) = r(t) + μ(t)Δt + σΔW
• Lognormal Model: Multiplicative drift - r(t+Δt) = r(t) * exp(μ(t)Δt + σΔW)

This fundamental difference affects how interest rates evolve and the properties of the resulting term structure models.