quiz- probability and distribution

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

quiz- probability and distribution

Postby sandipkumarshaw » Sun Feb 02, 2014 2:05 pm

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.
Choose one answer.
a. 0.0591 Correct
b. 0.06 Incorrect
c. 0.0576 Incorrect
d. 0.0563 Incorrect
The correct answer is A
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"

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

quiz- probability and distribution

Postby pradeeppdy » Tue Feb 04, 2014 6:39 am

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

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

quiz- probability and distribution

Postby pradeeppdy » Thu Apr 03, 2014 8:46 am

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


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