compounding rates

adehbone

Hi all, I have a really silly question. I have come across various expressions for calculating rates/discount factors when t < 1 year.

For example, Libor - 3%, to calculate a 3 Month rate => (1+ 3%) ^ (3/12) = 1.00742.

however I have also come across expressions such as : (1+ 3% * 3/12) = 1.0075

I believe for continuous compounding the first expressions applies. But I have seen both expressions used when no continuous compounding is specifically mentioned. This is from the Scheweser notes.

Any insights?

Thanks!

liangfeng

For continuous compounding we would use :- e^3%*3/12

The first one you gave was normal compounding

Second one is without compounding.

Hope this helps.

jmh530

thakurpratyush Wrote:
-------------------------------------------------------
> The first one you gave was normal compounding
>
> Second one is without compounding.
>
> Hope this helps.

When to use 1st one & when to use 2nd one ? Is there any tangible/clear rule ?

PalacioHill

I think this is the rule:

when it is LIBOR use this:
(1+ 3% * 3/12) = 1.0075

when other Rf rate use
(1+ 3%) ^ (3/12) = 1.00742