what do u mean by
1)buy a cap and selll a floor option
- sell a cap and buy a floor option
from the perspection of the issuer…
A cap pays off when a floating rate goes above a given (strike) rate; a floor pays off when a floating rate goes below a given (strike) rate.
The issuer of a floating-rate bond would buy a cap to protect himself from having to pay more interest when the reference rate rises. To finance that purchase, he will frequently sell a floor.
The purchaser of a floating-rate bond would buy a floor to protect himself from receiving too little interest when the reference rate falls. To finance that purchase, he will frequently sell a cap.
thanks sir…
can u please expalin the following sentence…
The duration of a zero coupn bond equals its term to maturity…
My pleasure.
That sentence is refering to the Macaulay duration of the zero-coupon bond. Macaulay duration is a weighted-average time to receipt of cash flows, where the weight on each time-to-cash-flow is the present value of the cash flow at that time divided by the sum of the present values of all of the cash flows.
Because a zero gets 100% of its cash flow at maturity, its Macaulay duration is 100% × time-to-maturity = time-to-maturity.
Modified duration gives the price sensitivity of a bond to a change in interest rates; it is equal to the Macaulay duration divided by (1 + YTM). Thus, unless the YTM = 0%, the modified duration of a zero is slightly less than its term to maturity.
I understood it sir…
thank u once again…
Good to hear.
You’re welcome.