Compounding option premium for interest rate call options

[blitzraider]

There is probably a simple concept I am forgetting but when we calculate the FV of the option premium to the date of the loan in an interest rate option

Why do we do

premium*((1+interest)*(maturity/360))

Instead of

premium*(1+interest)^(maturity/360)

I thought the second way (with the exponent) is how you compound interest. What am I missing?

[krokodilizm]

It’s because we use LIBOR, which are annualized rates. When un-annualizing them we use a simple interest and 360-day convention.

[S2000magician]

@krokodilizm

It’s because we use LIBOR, which are annualized rates. When un-annualizing them we use a _ simple interest _ and 360-day convention.

What you really mean is that LIBOR is quoted as a nominal rate, not an effective rate.

[krokodilizm]

@S2000magician

@krokodilizm

It’s because we use LIBOR, which are annualized rates. When un-annualizing them we use a _ simple interest _ and 360-day convention.

What you really mean is that LIBOR is quoted as a nominal rate, not an effective rate.

So that’s why it is manipulated so often…

[Victoryeo1984]

The formula should be Premium [1 + (nom rate)(maturity/360)] Premium [1+(1+effective rate) ^(maturity/360)-1]