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Interest Rate Volatility

Since the breakdown of the Bretton Woods exchange rate mechanism in the early 1970s, the volatility of both exchange rates and interest rates has increased greatly. This increase in volatility can be attributed to many factors, such as increased capital flows between countries, greater levels of international trade and the over-dependence of some countries on imported energy products.

 

This course describes how market participants can determine the expected level of future interest rate volatility from derivative instruments. In particular, you will learn about flat volatilities and base volatilities. You will also be introduced to volatility smiles and smirks, and their significance in the market.

  • OBJECTIVES

    On completion of this course, you will be able to:

    Measure historical interest rate volatility

    Distinguish between flat and base volatilities

    Identify how the phenomena of volatility smiles and smirks are caused

  • COURSE OUTLINE

    Topic 1: Measuring Historical Interest Rate Volatility

    Measuring Historic Volatility

    Measuring Historic Volatility  - The Steps Involved

    o Step 1: Calculate the Average/Mean

    o Step 2: Calculate the Variance

    o Step 3: Calculate the Standard Deviation

    Annualizing Volatility

    How ‘Normal’ are Libor Log Changes?

    Normally Distributed Log Changes

    Log-normally Distributed Rates

    Topic 2: Flat & Vase Volatilities

    Black Model

    Types of Volatility

    o Flat Volatility

    o Base Volatility

    Flat Volatility versus Base Volatility

    Topic 3: Smiles & Smirks in Interest Rate Volatilities

    Smile and Smirk Adjustments

    Volatility Smiles

    Adjusting ATM Volatilities due to Interest Rate Changes

    ATM Straddle – Example

    Adjusting ATM Volatilities for Pricing Options

    Volatility Smirks

  • PREREQUISITE KNOWLEDGE

  • ESTIMATED COMPLETED TIME

    60 Minutes

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