# why different compounding methods in derivatives vs. rest of the curriculum?

hi guys, lets say: T= 90days with act/360 r= 5% p.a. in most of the problems involving interest throughout the curriculum (e.g. in CF and FI) we used a method like this: FACE / (1+r*90/360) in the derivatives section this apparently would become FACE / (1+r)^(90/360) which is not the same. when we would be using continous compounding, like we were actually supposed to do, we’d be calculating FACE*exp(-r*90/360) and not FACE*exp(-r^(90/360)). why are we changing “methods”? cheers

sorry, first post was too general. my example refers to the --> options reading

LIBOR is an annualized discount rate based on simple interest. When working with LIBOR-based instuments (i.e floating rate loans, FRAs, interest rate options, caps and floors) unnualize by multiplying the LIBOR rate by t/360. To find the PV or to calculate fixed-rate bond yeilds use (1+r)^t/360

hi! thx for your answer. but, actually when doing FI calcs with our TI-BA II, to find the PV of a level-coupon bond for example we’re doing the following. say we have a bond with quarerly coupon PMTs @ r% p.a. N=T*4 I/Y=r/4 which is actually PV= … + (FACE+coupon) / (1+r/4)^N with 1/4 = 90/360 --> PV= … + (FACE+coupon) / (1+r*90/360)^N which should conceptually not be different from my earlier post. i think it’s starting to mess with my head

How about we start over? Can you state the pages in the CFA Books that you are talking about?

ok… e.g. schweser #5, page 206 or cfai #6, page 103 -> upper/lower bounds for options min european put value = max[X/(1+r)^(T-t)-S0,0] with T=4months=4/12years -> max[X/(1+r)^.25-S0,0] since in this 4months there is no compound interest, i dont understand why we’re not doing this: max[X/(1+r*.25)-S0,0]