Deck 20: The Market Model for Standard Derivatives

Question 1

What is a caplet?

Answer 1

A caplet is an option on interest rates with the following payoff:

Question 2

How is the pricing of a cap related to a caplet?

Answer 2

The price of a cap equals the sum of the caplets forming it.

Question 3

What is an at-the-money cap?

Answer 3

An at-the-money cap is a cap for which strike rate rK equals the corre- sponding swap rate.

Question 4

What is a floor?

Question 5

What is the relation between forward volatilities from Black's model and forward volatilities from the Black-Dermand-Toy model?

Question 6

What effect does mean reversion have on the shape of the implied forward volatility curve?

Question 7

What is flat volatility?

Question 8

You are given information on a 12-month cap, among which is the quoted volatility, you then want to obtain the price fo the 6 month caplet, can you simply take the quoted volatility and use as the input needed in Black's formula?

Question 9

What is the advantage of quoting securities in flat volatilities instead of prices?

Question 10

What is the forward swap rate?

Question 11

What is a swaption?

Question 12

What is a floorlet?

Question 13

What is a cap?

Question 14

What is the swaptions implied volatility?

Question 15

What determines the variation of the forward volatility and the shape of the forward volatility curve?

Question 16

How do we extract forward volatilities from flat volatilities?

Question 17

What is the source of flat volatility?

Question 18

What is forward volatility?

Question 19

How is the pricing of a floorlet related to a floor?