A cap on a floating rate note, from the bondholder’s perspective, is equivalent to:
Their answer is : writing a series of puts on fixed income securities.
Can someone please explain.
a cap is a series of long call option or selling a series of put option
can you please explain further? as in the payoffs?
A Cap simply means the rate will not go beyond a prespecified rate, and thus if the rate rises beyond the prespecified rate, the cap holder benefits.
So, what option benefits the holder when the price rises? that is definitely writing a Put Option.
Value of a Put Option increases when the price of the option rises beyond the strike price, and thus is similar to owing a Cap on a Fixed Income Security
thanks.
sorry i do not understand.
Let me repeat what is being asked. A cap on a floating rate note from a bondholder’s perspective is equivalent to “WRITING a series of Put on fixed income securities”.
if interest rates rise and value of the bond falls, then series of put that had been written would be more valuable. But that will be valuable to the holder of the puts not the one who wrote (sold) it. In this case he is the bond holder. Can someone please explain?
Imo- put writer expects that interest will not increase, if they do he loses. Anyone buying cap has similar expectations, that is why he buys a cap, which will be cheaper than a comparable straight bond. In return the person is ready to lose upside if int rate rises, which is similar to writing a put.