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wolfa10
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Joined: November 29th, 2018, 10:34 am

Duration of floaters with a floor

November 29th, 2018, 10:57 am

Hi all,
Can a floater with a floor and prepayment have a duration greater than the period until the next fixed interest day? And if so, why? What happens when the interest is negative?
Thank you!
 
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bearish
Posts: 5188
Joined: February 3rd, 2011, 2:19 pm

Re: Duration of floaters with a floor

November 29th, 2018, 12:31 pm

Hi all,
Can a floater with a floor and prepayment have a duration greater than the period until the next fixed interest day? And if so, why? What happens when the interest is negative?
Thank you!
Yes. Consider a 5 year USD floater paying Libir flat, floored at 10%. This is, for all practical purposes a fixed rate bond, and will thus have the corresponding duration.
 
wolfa10
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Posts: 2
Joined: November 29th, 2018, 10:34 am

Re: Duration of floaters with a floor

November 29th, 2018, 1:29 pm

Thank you! but how would you divide this kind of instrument with payment of = libor (L) + spread (S) with a floor of S in a synthetic position? And how would you calculate the duration then?
Do you know some good literature that adress this topic?
 
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bearish
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Joined: February 3rd, 2011, 2:19 pm

Re: Duration of floaters with a floor

November 29th, 2018, 2:35 pm

To the extent that the optionality in the floor is non-trivial you need a model. You might as well start with the Wikipedia page on interest rate caps and floors and go from there. This is not going to be done in a leisurely afternoon...
 
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wickedwit
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Joined: August 6th, 2011, 3:48 pm

Re: Duration of floaters with a floor

August 3rd, 2019, 2:18 pm

Something that you can do is take whatever cap or floor your bond has and go price out that cap or floor using the bonds average life from a model or some vector. That should compare to your structure's pricing.