Explanation:
The change in the short-term spot rate is given by:
Since the short-term rate started at 3%, the short-term rate after a month is 2.7%.
New short-term rate = $3% - 0.3% = 2.7%$
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Q.4016 Using Model 1, assume the current short-term interest rate is 3%, the short-term volatility is 100bps, and dw, a normally distributed random variable with mean 0 and standard deviation , has an expected value of zero. After one month, the realization of dw is -0.3. What is the change in the spot rate and the new spot rate?
| Change in spot | New Spot Rate | |
|---|---|---|
| I. | 0.25% | 2.25% |
| II. | −3% | 0.0% |
| III. | 0.6% | 3.6% |
| IV. | −0.3% | 2.7% |
A
I
B
II
C
III
D
IV
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