EXAMPLES 5.3 AND 5.5 IN HULL
- Thread starter fashepard
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Hi Frank,
When you say, "In 5.3 it was stated as 1% per annum and not converted" did you mean a different example?
A safe bet is to use/assume the same compound frequency as cash flow interval; e.g., if a mortgage pays monthly, the rate is likely to be monthly, an annual coupon bond would fairly be annual frequency.
(although cash flows are never continuous, yet that is the financial engineer's de facto)
To my knowledge, Hull (derivatives) is always operating in continuous compounding (e.g., cost of carry, forward rates, swaps)
But more broadly, IMO, you cannot always know. I frankly think the use of various compound frequencies is a symptom in the FRM of employing various authors. Any of them could be converted to another.
I would offer:
* From an exam standpoint, it should be indicated
* As you know, our learning goal is to see the frequencies are "merely" units and to have the ability to switch from one to another. A really great place to be is to see how we could apply Tuckman's bond pricing with Hull's penchant for continuous and, vice versa, to use Hull's continuous in computing implied forward rates.
* Tuckman's bonds are always semi-annual; he is following an established bond tradition, to my knowledge, which is US-centric b/c Treasuries pay coupons semi-annual. Hull is always continuous, Jorion is annual. But none is wrong, none is "correct" b/c we can always translate
David
When you say, "In 5.3 it was stated as 1% per annum and not converted" did you mean a different example?
A safe bet is to use/assume the same compound frequency as cash flow interval; e.g., if a mortgage pays monthly, the rate is likely to be monthly, an annual coupon bond would fairly be annual frequency.
(although cash flows are never continuous, yet that is the financial engineer's de facto)
To my knowledge, Hull (derivatives) is always operating in continuous compounding (e.g., cost of carry, forward rates, swaps)
But more broadly, IMO, you cannot always know. I frankly think the use of various compound frequencies is a symptom in the FRM of employing various authors. Any of them could be converted to another.
I would offer:
* From an exam standpoint, it should be indicated
* As you know, our learning goal is to see the frequencies are "merely" units and to have the ability to switch from one to another. A really great place to be is to see how we could apply Tuckman's bond pricing with Hull's penchant for continuous and, vice versa, to use Hull's continuous in computing implied forward rates.
* Tuckman's bonds are always semi-annual; he is following an established bond tradition, to my knowledge, which is US-centric b/c Treasuries pay coupons semi-annual. Hull is always continuous, Jorion is annual. But none is wrong, none is "correct" b/c we can always translate
David
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