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Ch04HullFundamentals7thEd

Ch04HullFundamentals7thEd - Interest Rates Chapter 4...

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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Interest Rates Chapter 4 1
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Types of Rates Treasury rates LIBOR rates Repo rates 2
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Measuring Interest Rates The compounding frequency used for an interest rate is the unit of measurement The difference between quarterly and annual compounding is analogous to the difference between miles and kilometers 3
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Continuous Compounding (Page 83) In the limit as we compound more and more frequently we obtain continuously compounded interest rates $100 grows to $ 100e RT when invested at a continuously compounded rate R for time T $100 received at time T discounts to $ 100e - RT at time zero when the continuously compounded discount rate is R 4
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Conversion Formulas (Page 83) Define R c : continuously compounded rate R m : same rate with compounding m times per year ( 29 1 1 ln / - = + = m R m m c c e m R m R m R 5
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Zero Rates A zero rate (or spot rate), for maturity T is the rate of interest earned on an investment that provides a payoff only at time T 6
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Example (Table 4.2, page 85) Maturity (years) Zero Rate (% cont. comp.) 0.5 5.0 1.0 5.8 1.5 6.4 2.0 6.8 7
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Fundamentals of Futures and Options Markets, 7th Ed, Ch 4, Copyright © John C. Hull 2010 Bond Pricing To calculate the cash price of a bond we
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