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Caps & Floors - Pricing

The use of caps and floors has increased significantly over the years as more companies attempt to hedge their interest rate exposures. Like options, caps and floors can be specifically arranged in such a way as to provide hedgers with a win-win scenario: if the market goes their way, they can choose not to exercise the cap/floor and accept the market rate, while if the market goes against them, they can choose to exercise the instrument and thereby reduce their potential loss. As you would expect, there is a cost associated with this type of hedging.

 

In this course, we will look at how caps and floors are priced in the market. We also look at the sensitivity of caps and floors to changes in key pricing variables.

  • OBJECTIVES

    On completion of this course, you will be able to:

    Recognize the determinants of cap and floor prices

    Price caps and floors

    Identify the price sensitivities associated with caps and floors

  • COURSE OUTLINE

    Topic 1: Determinants of Cap & Floor Prices

    Key Determinants

    o Strike Price

    o Underlying market price

    o Maturity

    o Expected market volatility

    Cap/Floor Pricing Formula

    o Cap premium

    o Floor premium

    Topic 2: Pricing of Caps & Floors

    Black Model

    o Black model

    o Pricing a Cap –Example using Black Model

    o Understanding probability distribution function

    o Volatility curves

    Binominal/Trinomial Trees

    Topic 3: Price Sensitivities of Caps & Floors

    Price Sensitivities

    o Forward Rate

    o Volatility of the forward rate

    o Time

    Measurements of Price Sensitivities

    o Delta

    o Factor sensitivity

    o Gamma

    o Vega

    o Theta

  • PREREQUISITE KNOWLEDGE

  • ESTIMATED COMPLETED TIME

    75 Minutes

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