Chapter 30 Convexity, Timing, and Quanto Adjustments

A popular two-step procedure for valuing a European-style derivative is:

  1. Calculate the expected payoff by assuming that the expected value of each underlying variable equals its forward value

  2. Discount the expected payoff at the risk-free rate applicable for the time period between the valuation date and the payoff date.

We first used this procedure when valuing FRAs and swaps. Chapter 4 shows that an FRA can be valued by calculating the payoff on the assumption that the forward interest rate will be realized and then discounting the payoff at the risk-free rate. Similarly, Chapter 7 extends this, showing that swaps can be valued by calculating cash flows on the assumption that forward ...

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