Forward Price... LIBOR

LorrinCFA

Table 1

Period | LIBOR Forward Rates | Implied Spot Rates

0

tarunajwani

ok lets try this

same question, same given rate curve, you know that LIBOR is rate p.a. simple rate so 6m interest is calced LIBOR/2

and choices are
a) 6.25
b) 6.35

which one is correct?

SFoyil

(1.057492^2)/1.052498 - 1


is approximately the same as

2 * .057492 - 052498

.... to the fifth decimal place. While the former is "exact" , at a pinch you can do the latter in an exam and get the right answer out of the choices.

Aztec's answer and the reasoning is correct .

maryli

I have always been of the mind that you /2 for LIBOR only as simple compounding is being used by definition (i.e. in FRA's, interest rate options etc.)

For spot rates & forward rates, these work with compounding therefore you must ^2 or ^(1/2)

Rasec

The issue here is not compounding, you have to compound in the above because you are talking about rates over many years (that has nothing with LIBOR or not). The LIBOR issue comes up in a different case, whether to multiply by 90/360 o raise that to 90/360. In the above regardless of the rate, you have to raise to number of periods.

This is a little tricky I know, but I'm sure in L1 CFAI textbook, there is an example which shows 6-month rates, where you divide by 2 before compounding. Also, if quarterly, you divide by 4, before compounding.

MiniMe7

I refreed to Schweser's Lvl I refresher handbook Page 89.

They show the foward rate estimation using spot rates , and they clearly show the compounding taking place.


I do remember hitting the divide in TVM calculations .

I am now confused becuase there was stuff about B.E.Y etc that's totally out of scope now.


But this year ( Lvl II ) I am taking care to do it only for LIBOR , never for spot rates.

In fact if you look at the spot rates in the table above , they are built up entirely by bootstrapping the forward rates , 1 step at a time , using compounding

bolligerallstar

I thought for Futures/Forwards we always go with compounding (take it to the power ^) and not add -on....

madaochenggong

Dreary , you got the wrong rate in there man.

Only LIBOR can be divided by 2 , 4 etc. Spot rates are compund rates , never simple return rates.

You are dividing 057492/2.

i.e. Spot Rates / 2 . Thats a no-no. Instead it can be ( 1+ LIBOR/2)

You want to compound the spot rates that's fine . But don't divide by 2 . Take Sqrt if you have to .

The answer is so close to 6.25 % that it is impossible to say its rounding error. It looks very close to exact.

random_walker47

you are right Dreary, if there were more choices between 6 and 6.5, it would be necessary to calc either your way or:
(1+0.06/2)x(1+0.065/2)



Edited 1 time(s). Last edit at Saturday, May 22, 2010 at 02:32PM by pfcfaataf.

MiniMe7

in this case I would not calc anything

just look at given forward rates
12