I cant understand what they are trying to say to me… do you use the coupon for next year today??? can somebody please give me the simple explanation of how to value the cap floater???
I been using Schweser and I dont think they covered this, at least I dont remmber. But I just took a look at it and I think I can help. Anyway thanks for bringing it to my attention. I guess if I explain one node, you should get the rest, I am assuming you understand all that is explained before page 312. Look at node NHHH in exibit 21 the value of any node is te PV of the val at its child nodes its child nodes NHHHH and NHHHL both have a val of 100 since that is what a bond pays at exp, its face value but you will also get 9.1987 coupon with that 100 the 9.1987 is decided at point NHHH when we are at “time” NHHH the interest rate is 9.1987 and thus that is the what you will get in the upcomming period…thats just how a floater works so discount ((100+9.1987)+(100+9.1987))/2 using the rate of 9.1987 and you get 100 is a matter of fact for a floater the value at reset is always a face value, because that bond will pay you what you require, it is always reset to market… remmber if a bond is paying less than it should, its value will go down if it is paying more than it should, its value goes up well guess what, a floater always pays what it should…so its always worth face val on rest dates… now exibit 22, has a slight diff that exibit 21… here at node NHHH the rate is 9.1987 if this was a regural floater, you should get 9.1987 at the end of the period but since it is a caped floater, and it is capped at 7.25, you will get 7.25 so your value at NHHH is ((100+7.25)+(100+7.25))/2 discounted at 9.1987 =98.215 common sense sais, a capped floater will always be worth less than a normal floater… because it will never pay you more that a normal floater, but it could pay you LESS i guess if a thing called “floored floater” exists, it would have to be worth more than a normal floater because it can pay you MORE but not LESS… this is the first time i see this stuff, but i think i did an OKAY job explaining it… i realy dont like how the coupon in the tree is placed at the time it is decided… maybe if it was placed at the point it is paid, it would have been much easier for you to see it???
a quick follow up, this is most likely the key to your problem "i realy dont like how the coupon in the tree is placed at the time it is decided… maybe if it was placed at the point it is paid, it would have been much easier for you to see it??? " look back at exibit 16, you see the coupon showing up at the node it is going to be paid at so at node nhhhh you get 100 +6.5 and you see 6.5 at node nHHHH well in exibit 21 they decided to follow a diff convention for some reason… probably to show you that the coupon is decide at the node before but realy if you wana make sense of it just “bump” the coupons up in the tree so the 9.1987 (coupon not the 9.1987%) should be bumped up to node Nhhhh and the 7.0053 should be bumped up to node nhhh…etc…
gulfcfa is correct. This is just to illustrate the point that coupon are determined at start of each period, though paid at the end of the period.
thank you for the answers, it was a great explanation gulfcfa
anytime, keep up the good work.