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The Handbook of Fixed Income Securities, Eighth Edition, 8th Edition by Steven V. Mann, Frank J. Fabozzi

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CHAPTERSIXTY-FIVEINTEREST-RATE CAPS AND FLOORS

GEORGE L. ALBOTA

DirectorCapital Markets/Market Risk ManagerBank of America Merrill Lynch, London

RADU S. TUNARU, PH.D.

Professor of Quantitative FinanceUniversity of Kent, Business School

Caps and floors and their twin instrument swaptions have become the main interest rate derivatives in fixed income markets. In this chapter, we discuss these important derivatives, trying to offer some insights without delving into complex mathematical modeling. We start by first describing caps and floors, their hybrid products and their potential applications. Then we consider some simple but still robust pricing considerations based on Black’s formula for caplets and floorlets, the main components of caps and ...

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