Reading 28 - example 11. (Interst rate options)

[sachin_patel]

When calculating future value of premium in this EOC, it uses notation rate * days/360

when finding out future value of loan, its using rate^(365/days) notation.

Why one is just multiplied, while one is raised to the power?

Thanks,

[S2000magician]

The former is a nominal rate (LIBOR).

The latter is an effective rate.

[sachin_patel]

got it… we are supposed to find effective rate in the example.

[sachin_patel]

Hi Magician, back again on to the same topic.

In reading 28 they are using raised to the power to get effective rate.

In reading 27 (forwards and futures) in first example in reading, they using FRA payoff and ultimately they are using multiplication method to find effective rate.

Any comments to intutively identify which one to use?

Thanks,

[S2000magician]

@sachin\_patel

Hi Magician, back again on to the same topic.

In reading 28 they are using raised to the power to get effective rate.

In reading 27 (forwards and futures) in first example in reading, they using FRA payoff and ultimately they are using multiplication method to find effective rate.

Any comments to intutively identify which one to use?

Thanks,

FRAs are normally quoted using LIBOR, which is not an effective rate; LIBOR is a nominal rate, which accounts for the multiplication of the interest rate rather than compounding.