Hi David,

In the Ho and Lee convexity adjustment, I wanted to understand how you get the continuously compounded futures rate.  Are you using the formula m*ln(1+Rm/m) . If yes what is the logic of taking m=365/90, I took m=4 and I got slightly different results. How relevant is the difference? Thanks in advance.

Ravi

Hi Ravi,

The difference is not relevant, but kudos for sweating details (this is how to pass...). My example mimics Hull Example 6.4 (I have no originality!). The logic is:

8% is actual/360 (i.e., the Eurodollar day count convention is actual/360)
So 2% is the 90-day Eurodollar rate
LN(1+2%)*365/90 annualized (per your formula) but also converts from actual/360 to actual/actual day count.

So, the idea is to convert an actual/360 daycount to an actual/actual, although IMO your is fine and i don’t think the difference here is particularly relevant...David

Ravi - As Paul has the same question, I posted here the underlying XLS to this, just FYI, just to show Hull’s and yours side by side - David