KIC000010 - L ~ I'f ..fO\lolGCd r d s , c , . E T, Lower I...

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Unformatted text preview: L ~ I'f ..fO\lolGCd r d s , c , . E T, Lower I Exhibit 18-7 Three-Year Binomial Interest-Rate Tree :I Y:ars Volatility and the Standard Deviation In the binomial model, it can be shown that the standard eviation of the one-year 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 interest-rate 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 one-year rate (r n ) is 4%, what is he standard deviation of the one-year 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 18-8 Three-Year Binomial Interest Rate ee with one-veer Forward Rates Today-yr rOI'WlJ,rd role J Year 2 Yl'lIrs J Y~ars r C ~a- . i ) 8 r - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -...
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KIC000010 - L ~ I'f ..fO\lolGCd r d s , c , . E T, Lower I...

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