In this second example, we consider the pricing of an IRS with a cap The details of the approach are shown in the following Bento Box template advanced example:
Our target is to compute the net present value of the swap as we did earlier.
An IRS cap is just like a standard IRS but with one key difference—at each payment date, we compute the maximum between (a) the difference between the floating rate and the strike and (b) zero. With this difference, we compute the value of a caplet; the cap is simply the sum of the caplets contained in the IRS.
The algorithm is shown ...