Could anyone explain how the value of a 2-year floor is equal to the value of a comparable 1-year European put option plus the value of a comparable 2-year put option?
Refember that a “FLOOR” is actually the combination of a bunch of “FLOORLETS”. Therefore a 2-year floor is actually made up of a 1 year floorlet and a 2 year floorlet. The individual floorlets are similar to european put options on rates - when rates go down you profit. Similar to a put on a stock - when the stock price goes down you profit.
As a side note - they are also similar to a call option on a bond. When rates go down and bond prices go up you profit. Same as a call on a stock - when the stock price goes up you profit.
All of these instruments will profit if rates fall.
Got it… well explained. Thanks 