If LIBOR is a nominal interest rate and not an effective interest rate, why in the final step of these types of questions do we take the result and set it to the power of (365/n) as opposed to multiplying it by (360/n)?
Safe to assume we will get most of the points on these kinds of questions if our work is mostly correct and use simple math as opposed to compounding the rate?
What types of questions?
Do you have an example?
i just came across this very issue in the official 2016 CFAI mock. the guideline answer from CFAI seemed to accept BOTH /365 and 360
Weird.
This is should be in the derivatives section where you have some sort of floating rate debt outstanding and you buy a call option to hedge against a rise in LIBOR. The question will ask for the EAR after taking into account the payoff on the call.
2016 CFA Q8C is an example of this. We use simple compounding for the first few steps, but to get the final answer, we use this:
Effective rate = ((Loan principal + Loan interest – Payoff from Call) / (Effective net loan proceeds))^(365/180) –1