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Let Two Time Points t1t _ { 1 } And t2t _ { 2 }

Question 8

Multiple Choice

Let two time points, t1t _ { 1 } and t2t _ { 2 } , on a yield curve be given, and let y(t1) y \left( t _ { 1 } \right) , y(t2) y \left( t _ { 2 } \right) be the yields at these maturities. You want to draw an interpolating curve between these maturities and are considering three alternatives:
-Linear (L) : y(t) =y(t1) +x(tt1) y ( t ) = y \left( t _ { 1 } \right) + x \cdot \left( t - t _ { 1 } \right) .
-Exponential (E) : y(t) =y(t1) ex(tt1) y ( t ) = y \left( t _ { 1 } \right) e ^ { x \left( t - t _ { 1 } \right) } .
-Logarithmic (G) : y(t) =y(t1) [1+ln(1+x(tt1) ) ]y ( t ) = y \left( t _ { 1 } \right) \left[ 1 + \ln \left( 1 + x \cdot \left( t - t _ { 1 } \right) \right) \right] .
Since the interpolated curves will not coincide perfectly except at the two end-points, interpolated yields will be higher under some methods versus the others. What is the rank-ordering of size of interpolated yields?


A) L<E<GL < E < G
B) E<G<LE < G < L
C) G<L<EG < L < E
D) E<L<GE < L < G

Correct Answer:

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