IRfoundationconcept
Discount Factors
Present value of one unit of currency paid at a future date.
01Intuition
Build the mental model first.
A discount factor is the price today of a future unit under the relevant collateral and currency rules.
ONE-LINE DEFINITION
Present value of one unit of currency paid at a future date.
02Mathematics
Now make it exact.
Notation and units
Decimal rates and volatilities, year-fraction time and continuous compounding unless stated otherwise.
03Assumptions
Every model has a price.
01
Educational conventions are stated explicitly and may simplify market quotation or settlement details.
02
Rates are continuously compounded unless the section says otherwise.
03
Inputs are deterministic in the base model.
“An unstated convention is a future reconciliation break.”— THEQUANTBATEMAN
04Market use
Why a quant cares.
Every cashflow PV and curve construction step depends on them.
Intuition→Mathematics→Implementation→Desk risk
05Desk view
FRONT OFFICE VIEW
The hedge has opinions.
Start with the quote convention, then ask which IR risk survives the hedge. A number without its convention is merely well-dressed ambiguity.
Ask Bateman about this model →06Related