## quiz- probability and distribution

sandipkumarshaw
Good Student
Posts: 25
Joined: Thu Jan 30, 2014 3:37 pm

### quiz- probability and distribution

An option trader is pricing a 1-year option. He is quoted an interest rate of 6% with semiannual compounding. In order to price the option correctly, he must convert this rate to a continuously compounded rate. Calculate the continuously compounded equivalent.
a. 0.0591 Correct
b. 0.06 Incorrect
c. 0.0576 Incorrect
d. 0.0563 Incorrect
The answer is solved for by setting interest rate equal to 2 x ln(1 + r). But my question is, log of 1.06 comes at 0.0583 then how the answer could be option "a"

Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm

### quiz- probability and distribution

We can't take log of 1.06 because the interest rate is semiannual compounding. we take (1.03)^2
Then we do log of 1.0609 = .0591

Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm

### quiz- probability and distribution

Or it can be calculated with the formula 2*In(1+r) . By putting the values we find 2*In (1+.03) . We have taken 0.03 because it is semiannual compounding . The ans is 0.0591 A