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Interest Rate Models

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Interest Rate Models

About this course: This course gives you an easy introduction to interest rates and related
contracts. These include the LIBOR, bonds, forward rate agreements, swaps, interest rate
futures, caps, floors, and swaptions. We will learn how to apply the basic tools duration and
convexity for managing the interest rate risk of a bond portfolio. We will gain practice in
estimating the term structure from market data. We will learn the basic facts from stochastic
calculus that will enable you to engineer a large variety of stochastic interest rate models. In this
context, we will also review the arbitrage pricing theorem that provides the foundation for pricing
financial derivatives. We will also cover the industry standard Black and Bachelier formulas for
pricing caps, floors, and swaptions. At the end of this course you will know how to calibrate an
interest rate model to market data and how to price interest rate derivatives.
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Who is this class for: This course is primary aimed at advanced graduates interested in
quantitative finance, along with finance professionals with an interest in interest rate models.
Prerequisites for this course: elementary probability theory and real calculus.

Created by: cole Polytechnique Fdrale de Lausanne


Taught by:

Damir Filipovi, EPFL

The Swissquote Chair in Quantitative Finance and Swiss Finance Institute Professor

Level

Intermediate

Commitment

5 weeks of study, 2 - 3 hours per week

Language

English

How To Pass

Pass all graded assignments to complete the course.

Syllabus
WEEK 1

Introduction
1 video, 4 readings
1. Video: Introduction
2. Reading: Evaluation
3. Reading: Certificate
4. Reading: Course discussions
5. Reading: Where to get help

WEEK 2

Interest Rates and Related Contracts

We learn various notions of interest rates and some related contracts. Interest is the rent paid on
a loan. A bond is the securitized form of a loan. There exist coupon paying bonds and zerocoupon bonds. The latter are also called discount bonds. Interest rates and bond prices depend
on their maturity. The term structure is the function that maps the maturity to the corresponding
interest rate or bond price. An important reference rate for many interest rate contracts is the
LIBOR (London Interbank Offered Rate). Loans can be borrowed over future time intervals at
rates that are agreed upon today. These rates are called forward or futures rates, depending on
the type of the agreement. In an interest rate swap, counterparties exchange a stream of fixedrate payments for a stream of floating-rate payments typically indexed to LIBOR. Duration and
convexity are the basic tools for managing the interest rate risk inherent in a bond portfolio. We
also review some of the most common market conventions that come along with interest rate
market data. Less
5 videos, 2 readings, 5 readings
expand
Graded: Interest Rates and Related Contracts
WEEK 3

Estimating the Term Structure

We learn how to estimate the term structure from market data. There are two types of methods.
Exact methods produce term structures that exactly match the market data. This comes at the
cost of somewhat irregular shapes. Smooth methods penalize irregular shape... More
4 videos, 4 readings
1. Video: Bootstrapping Example
2. Practice Quiz: Bootstrapping Example
3. Video: Exact Methods
4. Practice Quiz: Exact Methods
5. Video: Smoothing Methods
6. Practice Quiz: Smoothing Methods
7. Video: Principal Component Analysis
8. Practice Quiz: Principal Component Analysis
Graded: Estimating the Term Structure
WEEK 4

Stochastic Models
Models for the evolution of the term structure of interest rates build on stochastic calculus. We
start with a crash course in stochastic calculus, which introduces Brownian motion, stochastic
integration, and stochastic processes without going into mathematic... More

4 videos, 1 reading, 4 readings

1. Video: Stochastic Calculus
2. Reading: Definition of Brownian Motion without
Filtration
3. Practice Quiz: Stochastic Calculus
4. Video: Short Rate Models
5. Practice Quiz: Short Rate Models
6. Video: Heath-Jarrow-Morton Framework
7. Practice Quiz: Heath-Jarrow-Morton Framework
8. Video: Forward Measures
9. Practice Quiz: Forward Measures
Graded: Stochastic Models
WEEK 5

Interest Rate Derivatives

We apply what we learnt to price interest rate derivatives. Specifically, we focus on the standard
derivatives: interest rate futures, caps and floors, and swaptions. We derive the industry standard
Black and Bachelier formulas for cap, floor, and swaption pri... More
4 videos, 4 readings
1. Video: Interest Rate Futures and Convexity
Adjustment
2. Practice Quiz: Interest Rate Futures and Convexity
Adjustment
3. Video: Caps and Floors
4. Practice Quiz: Caps and Floors
5. Video: Swaptions
6. Practice Quiz: Swaptions
7. Video: Calibration Example
8. Practice Quiz: Calibration Example
Graded: Interest Rate Derivatives
WEEK 6

Final Quiz

Graded: Final quiz

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Creators
cole Polytechnique Fdrale de Lausanne

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