calibrating Binomial Tree

[jounin83]

Hi All,

as we know from equation 4 (reading 42) :

[1 + r(T* + T)]_^(_T* + T) = [1 + r(T*)]^T* x [_1 + f(T*,T)]^_T

_[1+r(2)]^2 = [1+r(1)] x [1+f(1,2)] ^2 _

refer to Blue Box 4 (Reading 43) :

S₁ = 2.0%, S₂ = 3.015% and S₃ = 4.055%.

(1.03015)^² = (1.02)(1+F_1,2)

anyone can explain why the formula on reading 43 missing the ^2?

Thanks

[S2000magician]

@jounin83

Hi All,

as we know from equation 4 (reading 42) :

[1 + r(T* + T)]_^(_T* + T) = [1 + r(T*)]^T* x [_1 + f(T*,T)]^_T

_[1+r(2)]^2 = [1+r(1)] x [1+f(1,2)] ^2 _

refer to Blue Box 4 (Reading 43) :

S₁ = 2.0%, S₂ = 3.015% and S₃ = 4.055%.

(1.03015)^² = (1.02)(1+F_1,2)

anyone can explain why the formula on reading 43 missing the ^2?

Thanks

It’s missing it because it doesn’t belong there. Note what I crossed out in your first formula. The exponents on the right have to add up to the same value as the exponent on the left.

I wrote an article on calculating forward rates from spot rates that may be of some help here: http://financialexamhelp123.com/calculating-forward-rates-from-spot-rates/

[jounin83]

@S2000magician

as we know from equation 4 (reading 42) :

_[1+r(2)]^2 = [1+r(1)] x [1+f(1,2)] ^2 _

It’s missing it because it doesn’t belong there. Note what I crossed out in your first formula. The exponents on the right have to add up to the same value as the exponent on the left.

I wrote an article on calculating forward rates from spot rates that may be of some help here: http://financialexamhelp123.com/calculating-forward-rates-from-spot-rates/

Hi Sir,

I think we have a different sign here.

In curriculum it refer to forward rate for a two-year zero issued one year from today, f(1,2).

That 1st formula above i copied directly from curriculum.

Thanks