CT8 S2014 Question 4'

Discussion in 'CM2' started by Jia Syuen, Sep 17, 2019.

  1. Jia Syuen

    Jia Syuen Active Member

    In the examiners' report, the given solution shows that q=(1.04^2-0.8)/(1.3-0.8).
    I thought the formula was q=(e^rt-d)/(u-d)? Why it's different?
     
  2. Anna Bishop

    Anna Bishop ActEd Tutor Staff Member

    Hi Jia

    It's because the exam question involves an effective interest rate, i, rather than a force of interest (= continuously compounded rate), r.

    Going back to CT1/CM1 days, the force of interest is defined as:

    r = ln(1 + i)

    So that:

    exp(r) = (1 + i)
    exp(rt) = (1 + i)^t

    Hence why we have exp(2r) = 1.04^2 in this question.

    Anna
     
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