Options, Futures, and Other Derivatives, Ninth Edition

Chapter 4 Interest Rates

Interest rates are a factor in the valuation of virtually all derivatives and will feature prominently in much of the material that will be presented in the rest of this book. This chapter deals with some fundamental issues concerned with the way interest rates are measured and analyzed. It explains the compounding frequency used to define an interest rate and the meaning of continuously compounded interest rates, which are used extensively in the analysis of derivatives. It covers zero rates, par yields, and yield curves, discusses bond pricing, and outlines a “bootstrap” procedure commonly used by a derivatives trading desk to calculate zero-coupon Treasury interest rates. It also covers forward rates and forward ...