-1
$\begingroup$

I am working on a problem in Davidson and Herskovitz workbook titled the Mortgage-Backed Securities Workbook. The questions asks to find the total opportunity cost to the investor of having a $1 million cashflow delayed for 15 days and the current risk free interest rate is 6.5% actual/actual. I first converted 6.5% into a daily rate and then tried to compound the interest on 1 million dollars, but it was deemed incorrect. The correct answer is 2671.23.

Their is also an example, but this time the current risk free rate is 6.25% and the book tells us each delay costs 171.23. The investor is still supposed to receive 1 million. I am assuming one could take the 171 multiply it by 15 to get the total, but why not 14 to account for timing?

$\endgroup$
  • 1
    $\begingroup$ By convention, for periods less than 6 months here is no compounding, it is just linear ("simple interest"): (15/365)*0.065 = 0.0267123 $\endgroup$ – noob2 Apr 3 '17 at 13:49
  • $\begingroup$ I would put that as an answer $\endgroup$ – Jack Armstrong Apr 3 '17 at 14:26
1
$\begingroup$

These calculations are a matter of convention and standard practice (which are somewhat arbitrary, and not necessarily the way I would have defined it).

A compounding period is defined, which is by default 1 year (except for US treasuries where it is 6 months). For periods shorter than this, compounding is not used, but rather "simple interest" is used, which amounts to a linear interpolation. So for "15 days and the current risk free interest rate is 6.5% actual/actual" we would do (15/365)*0.065 = 0.0267123 . On 1 million it is 2671.23

| improve this answer | |
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.