- CFA Exams
- 2023 Level II
- Topic 6. Fixed Income
- Learning Module 30. Valuation and Analysis of Bonds with Embedded Options
- Subject 7. Valuation and Analysis of Capped and Floored Floating-Rate Bonds
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Subject 7. Valuation and Analysis of Capped and Floored Floating-Rate Bonds PDF Download
We can use the arbitrage-free framework to value capped and floored floaters.
Value of capped floater = Value of straight bond - Value of embedded cap Value of floored floater = Value of straight bond + Value of embedded floor
The cap provision in a floater is an issuer option that prevents the coupon rate from increasing above a specified maximum rate. The value of a capped floater should be lower than the value of an otherwise similar straight bond.
The floor provision in a floater is an investor option that prevents the coupon from decreasing below a specified minimum rate.
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