Black swan and Nominal annual rate: Difference between pages

From ACT Wiki
(Difference between pages)
Jump to navigationJump to search
imported>Doug Williamson
(Add links.)
 
imported>Doug Williamson
(Link with Coupon rate page.)
 
Line 1: Line 1:
''Risk management''.
The rate of return - or cost of borrowing - ''per annum'' named or quoted in a market, under the quoting convention for the given market.


An apparently unusual event of very high impact.


Particularly one which - before it happened - was believed in error to be highly improbable, or even impossible.
Market quotations are usually given per annum, and for this reason the term ''nominal rate'' is often used interchangeably with nominal annual rate.




The use of the term in finance derives from the widespread historical (and wrong) belief in the Northern hemisphere that black swans did not exist.  This wrong belief was held in the period before the common occurrence of black swans in the Southern hemisphere had been reported in the North.
'''Example 1'''


The concept was popularised in a 2007 book by Nassim Nicholas Taleb - "The Black Swan".
GBP overnight interest payable at the periodic rate of 0.014% per day, would conventionally be quoted on a nominal annual basis as:


= number of times the period fits into a conventional year x periodic rate


Taleb summarises the problem in risk management as "the confusion of <u>absence of evidence</u> of Black Swans (or something else) for <u>evidence of absence</u> of Black Swans (or something else)".
= 365 x 0.014%


This means that the existence of financial "black swans" tends to lead to systematic under-assessment and <u>understatement</u> of financial risk.
= 5.11%.




<span style="color:#4B0082">'''''Turning black swans white'''''</span>
The nominal annual rate is sometimes also known as a 'quoted rate', 'market rate, or 'nominal rate'.


:Taleb points out that black swan events depend on the observer, and the information and analysis obtained and applied by him or her.
The nominal annual rate should not be confused with the effective annual rate, which is usually different.


:Being slaughtered shortly before Christmas is a black swan surprise for a turkey; especially following 1,000 days of consistent - apparently predictable - feeding and friendliness from humans.


:The slaughter of the turkey is not a black swan event for the human butcher.
'''Notation'''


:Turkeys need to gather more information and to analyse it.
Nominal annual interest rates and yields are often denoted by 'R'.


:''How not to be a sucker - A Black Swan is relative to knowledge - The Black Swan, 2010 pp40-44.''
This distinguishes them from periodic interest rates and yields (r), and from effective annual rates (EAR).




'''Conversion formulae'''


<span style="color:#4B0082">'''''Robustness not fragility'''''</span>
Using the notation above:


The key message from Taleb's work is about seeking robustness and avoiding fragility.
R = nominal annual interest rate or yield


:"You have to avoid debt because debt makes the system more fragile. You have to increase redundancies in some spaces.
r = periodic interest rate or yield


:You have to avoid optimization. That is quite critical for someone who is doing finance to understand because it goes counter to everything you learn in portfolio theory....
n = number of times the period fits into a conventional year


:I have always been very sceptical of any form of optimization. In the black swan world, optimization isn't possible.


:The best you can achieve is a reduction in fragility and greater robustness.
'''''To convert from a periodic rate (r) to a nominal annual rate (R)'''''


R = r x n


:You may have heuristics, but not an optimization rule.


:I hope the message will finally get across because I haven't succeeded yet.
'''''To convert from a nominal annual rate (R) to a periodic rate (r)'''''


:People talk about black swans but they don't talk about robustness, which is the real lesson of the black swans."
r = R / n


:''Living with Black Swans - Nassim Nicholas Taleb.''


'''Example 2'''


== See also ==
GBP interest is quoted at a nominal annual rate of 5.11% for daily interest calculation.
* [[COVID-19]]
 
* [[Fat tail]]
Calculate the periodic rate per day.
* [[Guide to risk management]]
 
* [[Heuristic]]
 
* [[Moody's]]
r = R / n
* [[Optimisation]]
 
* [[Portfolio analysis]]
= 5.11% / 365
* [[Probability]]
 
* [[Redundancy]]
= 0.014%
* [[Risk]]
 
* [[Stress test]]
 
* [[Unicorn]]
 
'''Example 3'''
 
The periodic rate for GBP interest is 0.01% per day.
 
Calculate the nominal annual rate.
 
 
R = r x 365
 
= 0.01% x 365
 
= 3.65%




== External link ==
== See also ==
[https://www.moodysanalytics.com/-/media/article/2020/weekly-market-outlook-coronavirus-may-be-black-swan-like-no-other.pdf Coronavirus may be a black swan like no other: Moody's]
* [[Continuously compounded rate of return]]
* [[Coupon rate]]
* [[Daily rate]]
* [[Day count conventions]]
* [[Effective annual rate]]
* [[Money market]]
* [[Nominal]]
* [[Periodic discount rate]]
* [[Periodic rate of interest]]
* [[Periodic yield]]
* [[Quarterly rate]]
* [[Semi-annual rate]]


[[Category:Identify_and_assess_risks]]
[[Category:Manage_risks]]

Revision as of 22:18, 11 November 2015

The rate of return - or cost of borrowing - per annum named or quoted in a market, under the quoting convention for the given market.


Market quotations are usually given per annum, and for this reason the term nominal rate is often used interchangeably with nominal annual rate.


Example 1

GBP overnight interest payable at the periodic rate of 0.014% per day, would conventionally be quoted on a nominal annual basis as:

= number of times the period fits into a conventional year x periodic rate

= 365 x 0.014%

= 5.11%.


The nominal annual rate is sometimes also known as a 'quoted rate', 'market rate, or 'nominal rate'.

The nominal annual rate should not be confused with the effective annual rate, which is usually different.


Notation

Nominal annual interest rates and yields are often denoted by 'R'.

This distinguishes them from periodic interest rates and yields (r), and from effective annual rates (EAR).


Conversion formulae

Using the notation above:

R = nominal annual interest rate or yield

r = periodic interest rate or yield

n = number of times the period fits into a conventional year


To convert from a periodic rate (r) to a nominal annual rate (R)

R = r x n


To convert from a nominal annual rate (R) to a periodic rate (r)

r = R / n


Example 2

GBP interest is quoted at a nominal annual rate of 5.11% for daily interest calculation.

Calculate the periodic rate per day.


r = R / n

= 5.11% / 365

= 0.014%


Example 3

The periodic rate for GBP interest is 0.01% per day.

Calculate the nominal annual rate.


R = r x 365

= 0.01% x 365

= 3.65%


See also

Retrieved from ‘https://wiki.treasurers.org/w/index.php?title=Black_swan&oldid=34460’