How to decompose future prices into FRA's
Posted: July 16th, 2007, 8:04 pm
by braveyellowj
Hello,Could anyone help answer how to decompose future prices into a series of forward rate agreement?For example, a future option with maturity T,Partition [0,T] into T0,T1, T2, ... TNThe ith FRA goes from T(i-1) to Ti.Thank you very much.
How to decompose future prices into FRA's
Posted: July 16th, 2007, 10:45 pm
by NorthernJohn
There are several methodologies. It is important to note that there is no one well agreed methodology. If you want a very simple method, that some very successful FRA traders use, just linearly interpolate futures rates. Mathematically, it does not look god, but it tends to be close, and I know traders who really trade this way.You just need to make sure that the rate for a future, R, is not simply calculated by 100 - price. There is a convexity adjustment in there too.