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 View Poll Results: How do you do discounting when it's not specified in the question? Continuous discounting: S * exp(-r%*t/12) 8 61.54% Effective annual rate: S / (1+r%)^(t/12) 3 23.08% Annual percentage rate: S / (1+r%*t/12) 0 0% Others: Please specify 2 15.38% Multiple Choice Poll. Voters: 13. You may not vote on this poll

#1
04-23-2012, 02:05 PM
 ASstudent SOA Join Date: Nov 2011 Posts: 18
General question on how do you do discounting?

When you are given interest rate = r% p.a. and the question does not specify how discounting should be done. Which approach would you use?

While it's intuitive for some models (e.g. continuous discounting as a part of Black-Scholes formula), let's assume something in a more general context, like bond coupons and binomial trees.

Last edited by ASstudent; 04-23-2012 at 02:11 PM..
#2
04-23-2012, 02:11 PM
 mlschop Member SOA Join Date: Sep 2005 Posts: 36,417

I always use continuous, only because I was in the habit of using annual effective rate method, and would make some silly mistakes (like forgetting that the time steps in a binomial tree were x months instead of 1 year, and dividing by 1.05 instead of (1.05^(x/12)).

Using continuous kind of forces that t in my face and helps me remember not to make this stupid mistake.
#3
04-23-2012, 02:18 PM
 Jereme Member SOA Join Date: May 2009 Location: Omaha, NE Studying for QFI Adv College: Portland State University Alumni Favorite beer: Dry Stout Posts: 105

My impression is that if the question does not state what form they are in then we should just state our assumption and move on with the calculation.
#4
04-25-2012, 12:39 PM
 PAK Eddy Chan, FSA, CERA, MAAA SOA AAA Join Date: Aug 2006 Favorite beer: Saki Posts: 3,260

If the question does not specify, either approach is fine.
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 Tags discounting, interest rate