1. Interest Rates Chapter 4 1 Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 2008

2. 2 Types of Rates Treasury rates LIBOR rates Repo rates

3. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20083 Continuous Compounding (Page 77) In the limit as we compound more and more frequently we obtain continuously compounded interest rates $100 grows to $ 100e RT when invested at a continuously compounded rate R for time T $100 received at time T discounts to $ 100e -RT at time zero when the continuously compounded discount rate is R

4. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20084 Terms used A zero coupon rate (or spot rate), is the rate of interest earned on an investment that starts today and lasts for n years To calculate the cash price of a bond we discount each cash flow at the appropriate zero rate The bond yield is the discount rate that makes the present value of the cash flows on the bond equal to the market price of the bond

5. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20085 Forward Rates The forward rate is the future zero rate implied by today’s term structure of interest rates

6. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20086 Calculation of Forward Rates Table 4.5, page 83 n -yearForward Rate zero ratefor n th Year Year ( n )(% per annum) 13.0 24.05.0 34.65.8 45.06.2 55.36.5

7. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20087 Forward Rate Agreement A forward rate agreement (FRA) is an agreement that a certain rate will apply to a certain principal during a certain future time period

8. Options, Futures, and Other Derivatives 7th Edition, Copyright © John C. Hull 20088 Duration of a bond shows the relationship between a change in a bond and its yield Duration (page 87-88)

9. Options, Futures, and Other Derivatives 7 th Edition, Copyright © John C. Hull 20089 A Eurodollar is a dollar deposited in a bank outside the United States Eurodollar futures are futures on the 3- month Eurodollar deposit rate (same as 3- month LIBOR rate) One contract is on the rate earned on $1 million A change of one basis point or 0.01 in a Eurodollar futures quote corresponds to a contract price change of $25 Eurodollar Futures (Page 136-141)