A key element in the construction of the Black Derman Toy interest rate model is the setting up and running of EXCEL’s Solver function. The Solver functionality links various parts of the model together, the inputs- initial zero curve rates and their volatilities, the calculation cells – price lattices and short rate tree, and the [...]
The Black Derman Toy (BDT) model is a one-factor, no-arbitrage interest rate model. One-factor in that the entire term structure of interest rates can be inferred with reference to the process underlying the short rates derived. No-arbitrage in that the term structure derived is exactly consistent with the current term structure- the zero curve yield [...]
Practice Test Exam Question Solution for Pricing Interest Rate Swaps – MBA course Derivatives I & II
Here is abbreviated partial solved solution to the practice exam question posed earlier. The practice exam question was used in Derivatives Pricing course taught to MBA students earlier in August 2012. The solution is presented in two parts. The [...]
The Cox-Ingersoll-Ross (CIR) interest rate model is a one-factor, equilibrium interest rate model. One factor in that it models the short – term interest rate and equilibrium in that it uses assumptions about various economic variables (e.g. mean reversion) to derive a process for determining this rate.
We have already provided a detailed theoretical overview in [...]
Addendum: How to conduct a Principal Component Analysis in EXCEL
There are a couple of problems that the user may face after running the Solver function in EXCEL for the Principal Component Analysis of treasury yield rates.
1. Dummy Values for the Eigenvector matrix
The seed values that are put in the eigenvector matrix have an impact on [...]
Monte Carlo simulation techniques are a useful tool in finance for pricing options especially when there are a large number of sources of uncertainty (in modeling terms: state variables) involved. Unlike Black Scholes formula for which closed formed solutions usually do not exist when there are three or more state variables or numerical methods like [...]
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The ICAAP (Internal Capital Adequacy Assessment) Roadmap post reviews the core topics in a crash course format for Internal Capital Adequacy Assessment.
INTEREST RATE MODELLING
Interest Rate Modelling: Introduction
Interest Rate Forecasting: Using CIR (Cox Ingersoll Ross) Model: Introduction
Interest Rate Forecasting: Using CIR (Cox Ingersoll Ross) Model: Estimating Parameters & Calibrating the CIR Model
Interest Rate Forecasting: Using CIR (Cox Ingersoll Ross) Model: Simulating the term structure of interest rates
Interest Rate Models: Black, Derman and Toy [...]
In this post we will consider how the Black-Derman-Toy (BDT) short rate binomial tree will be used to price options on bonds.
Pricing Options
The BDT model may also be used to price put or call options on bonds. For the purpose of calculating these prices it is important to generate the entire short interest rate tree [...]
