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A non-option financial instrument that has embedded optionality, such as an interest rate cap, can also have an implied volatility. Implied volatility, a forward-looking and subjective measure, differs from historical volatility because the latter is calculated from known past returns of a security.
To determine the cheapest bond in a basket of deliverable bonds against a futures contract, implied repo rate is computed for each bond; the bond with the highest repo rate is the cheapest. It is the cheapest because it has the lowest initial value to yield a higher return provided it is delivered with the stated futures price.
Market conditions: Major economic events — such as interest rate changes, unemployment data, market crashes or geopolitical tensions — can impact market volatility and, consequently, implied ...
It is worth noting that the normal SABR implied volatility is generally somewhat more accurate than the lognormal implied volatility. The approximation accuracy and the degree of arbitrage can be further improved if the equivalent volatility under the CEV model with the same β {\displaystyle \beta } is used for pricing options.
Interest rate changes are among the only means that the federal government has to control the U.S. economy. Typically, the Federal Reserve raises interest rates to help lower prices during a time ...
Similarly, an interest rate floor is a derivative contract in which the buyer receives payments at the end of each period in which the interest rate is below the agreed strike price. Caps and floors can be used to hedge against interest rate fluctuations. For example, a borrower who is paying the LIBOR rate on a loan can protect himself against ...
Each forward rate is modeled by a lognormal process under its forward measure, i.e. a Black model leading to a Black formula for interest rate caps. This formula is the market standard to quote cap prices in terms of implied volatilities, hence the term "market model".
Triangular arbitrage opportunities may only exist when a bank's quoted exchange rate is not equal to the market's implicit cross exchange rate. The following equation represents the calculation of an implicit cross exchange rate, the exchange rate one would expect in the market as implied from the ratio of two currencies other than the base currency.