FRM Part I · FRM Exam Part I · Pricing Conventions, Discounting, and Arbitrage
The 3-year spot rate is 4.00% with annual compounding. What is the equivalent 3-year discount factor?
The 3-year discount factor is 0.8890, calculated as one divided by 1.04 cubed. This reflects annual compounding of the 4% spot rate over three years; using simple subtraction or only one year of discounting gives incorrect values.
- A0.8890Correct
- B0.8800
- C0.9615
- D0.8638
Explanation
d(3) = 1/(1.04)^3 = 1/1.124864 = 0.8890. The 0.8800 option subtracts 4% three times from one. The 0.9615 option is the 1-year factor. The 0.8638 option compounds at 5%.
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