13.17 Defining a Rate Index Formula

The purpose of the Stochastic Rate Index assumption rule is to define a forecast of the index rates (such as Libor or Prime) based on the Monte Carlo forecast of the risk-free rate. This forecast is applicable for every time t in the future and every scenario.“Future” means any time after the As-of-Date.

The rate index primarily should be defined under the following situations:

• The index is a contractual function of the risk-free yield.
• The index is defined through a conjunction of exogenous factors, in which case time series analysis finds the best formula.

In this section, we analyze one important special case of a contractual function, namely how to translate simple rates (zero-coupon yields) into par bond coupon rates for a risk-free bond with one payment. We first describe the general formula a user can enter.