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Unformatted text preview: L ~ I'f ..fO\lolGCd r d s , c , . E T, Lower I Exhibit 187 ThreeYear Binomial InterestRate Tree :I Y:ars Volatility and the Standard Deviation In the binomial model, it can be shown that the standard eviation of the oneyear forward rate is equal to rocr. The standard deviation is a statistical measure of voLatility. For now it is important to see that the process that we assumed enemies the binomial interestrate tree (or equivalently, the orward rates) implies that volatility is measured relative 10 the urrent level of rates. :E:XAI\'IPI...E.If cris 10% and the oneyear rate (r n ) is 4%, what is he standard deviation of the oneyear forward rate? What is if '0 t2%? roa = ' 4% x 10% = 0.4% or 40 basis points roc; == 12% )( 10% == 1.2% or 120 basis pctnrs '_"""',",!W"'.e_"h"~'>;""" """"~'(;" ...."",,, ... ' xhlbit 188 ThreeYear Binomial Interest Rate ee with oneveer Forward Rates Todayyr rOI'WlJ,rd role J Year 2 Yl'lIrs J Y~ars r C ~a . i ) 8 r                                               ...
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 Fall '11
 Hood
 Interest, Volatility

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