Banner Ad 1



No announcement yet.

Stochastic Interest Rate Models

  • Filter
  • Time
  • Show
Clear All
new posts

  • Stochastic Interest Rate Models

    The question reads as follows:
    On average a company earns interest on its funds at 10% p.a. However in any year the yield of the company's funds is equally likely to take on a value between 8% and 12%.
    In return for a single payment of 1 735.50, the company offers an investor a payment of 1 000 at the end of each year for 2 years.
    Calculate the expected value at the end of the contract of the company's accumulated profit.
    Calculate the standard deviation of the accumulated profit.

    I have managed to calculate E[accumulated profit] = -0.045
    But I am not sure where to begin to calculate the standard deviation, so any help will do!

  • #2
    Show your work on how you came up with your expected profit.


    • #3
      this is a binomial tree that does not recombine. At any given point for any tree,
      u/d=e^(2sigma*sqrt(h)) You are given u and d, so you can solve the equation.
      "As far as I'm concerned, I prefer silent vice to ostentatious virtue." Albert Einstein
      "It is hard to tell if a man is telling the truth when you know you would lie if you were in his place." H. L. Mencken