What is meant by implied volatility?
What will be an ideal response?
Market participants estimate yield volatility in one of two methods: historical volatility or implied volatility. The implied volatility method is more complicated than the historical method as it involves using models for valuing option-type derivative instruments to obtain an estimate of what the market expects interest-rate volatility is. In any option pricing model, the only input that is not observed in the model is interest-rate volatility. In practice, one assumes that the observed price for an option-type derivative is priced according to some option pricing model. The calculation then involves determining what interest-rate volatility will make the market price of the option-type derivative equal to the value generated by the option pricing model. Because the expected interest-rate volatility obtained is being "backed out" of the model, it is referred to as implied volatility.
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Answer the following statement true (T) or false (F)