Interest Rate Models

Interest Rate Models - Interest Rate Models Copyright...

Info iconThis preview shows pages 1–11. Sign up to view the full content.

View Full Document Right Arrow Icon
Interest Rate Models Copyright © 1996-2006 Investment Analytics
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 2 Interest Rate Models ± Model types, characteristics ± Model Taxonomy ± One-Factor models ± Vasicek ± ± ± Black-Derman-Toy Model Two Factor Models ± ± ± ± Heath-Jarrow-Morton
Background image of page 2
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 3 Interest Rate Models ± Used to: ± Value derivatives, esp. non-standard ± Compute hedge ratios ± Assess portfolio risk ± Provides a consistent framework for valuation, hedging & risk-management
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 4 Types of Model ± Extensions of Black-Scholes ± Widely used for caps/floors (Black’s model) ± Models of the short term interest rate ± Easy to implement ± Many varieties, e.g. BDT, HW ± Models of entire yield curve ± Most difficult ± Usually simplified to two factors (e.g. HJM)
Background image of page 4
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 5 ± Very popular instruments ± Great demand for caps due to increased interest rate volatility ± Market very liquid ± Used to calculate market’s view of interest rate volatility
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 6 ± Caps: ± Limits Upside Risk / Gain ± Series of interest rate call options ± Caps interest rate, or equity index return ± Floor: ± Limits Downside Risk / Gain ± Series of interest rate put options ± Collar ± ± Fixes interest rate or equity index within a band
Background image of page 6
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 7 Interest Rate Caps ± Contract terms ± Cap strike rate, R x (7%) ± Term (3 years) ± Reset frequency (quarterly) ± Reference rate (LIBOR) ± Principal ($1MM) ± Payment from seller to buyer: ± 0.25 x $1MM x Max(LIBOR - R x , 0) ± In arrears, usually starts after 3 months ± Each piece is called a “caplet”
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 8 Collar ± Combines Floor(s) and Cap(s) ± Limits upside potential and downside risk ± ± Premium from calls offsets cost of puts ± Zero Cost Collar: ± Special case where Put Premium = Call Premium ± Net cost is zero ± Typically used to lock in gains after market rally
Background image of page 8
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 9 Collared FRN Coupon(%) LIBOR
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Copyright © 1996-2006 Investment Analytics Interest Rate Models Slide: 10 Black’s Model ± Simple extension of Black-Scholes ± Originally developed for commodity futures ± Used to value caps and floors ± Let F = forward price, X = strike price ± Value of call option: t d d t t X F d d XN d FN e C rt = + = = σ 1 2 2 1 2 1 ) 2 / ( ) / ln( )] ( ) ( [
Background image of page 10
Image of page 11
This is the end of the preview. Sign up to access the rest of the document.

This document was uploaded on 11/04/2011 for the course ECON 421 at CUNY York.

Page1 / 109

Interest Rate Models - Interest Rate Models Copyright...

This preview shows document pages 1 - 11. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online