Suppose Libor caps and floors at the same strike rate are unequal in price.Suppose that,ceteris paribus,there is a sudden increase in interest-rate volatility.Which of the following statements is valid?
A)Caps and floors will increase in value,but caps will increase by more than floors.
B)Caps and floors will increase by the same amount.
C)Caps and floors will increase in value,but caps will increase by less than floors.
D)There is insufficient information to determine the answer.

Question

Quizplus · Accepted Answer

From the parity relation between caps,floors,and swaps,we know that the difference in price between caps and floors equals the NPV of the swap.When volatility changes,the price of the swap does not change.Hence,the difference in price between caps and floors does not change,even though they increase in value.

Suppose Libor Caps and Floors at the Same Strike Rate