The Chief Risk Officer (CRO) at a hedge fund has tasked the risk team with developing a term-structure model to adjust interest rates for the fund's options pricing strategy. The risk team is deliberating between two models: the Ho-Lee model, which incorporates time-varying drift, and the Cox-Ingersoll-Ross (CIR) model, which includes time-varying volatility. Which of the following descriptions accurately defines the specified model?

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In the Ho-Lee model, the drift of the interest rate process is presumed to be constant.

3.9%

In the Ho-Lee model, when the short-term rate is above its long-run equilibrium value, the drift is presumed to be negative.

13.0%

In the Cox-Ingersoll-Ross model, the basis-point volatility of the short-term rate is presumed to be proportional to the square root of the rate.

71.4%

In the Cox-Ingersoll-Ross model, the volatility of the short-term rate is presumed to decline exponentially to a constant long-run level.

11.7%

Financial Risk Manager Part 2