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KI Floor
Hi,I am looking at an interest Rate Floor with a Knock in based on an FX rate, for example, a USD interest rate floor of 5% which only knocks in if USD-JPY reaches 100.To value this, would it be sufficient to value the Floor as normal, calculate the probability of the FX rate hitting the barrier and multiply the results?Any advice appreciated.Thanks.
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- sportbilly
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KI Floor
That is not sufficient. You need to worry about timing issues too. If the knock-in happens earlier that means you will have more floorlets, meaning a greater value for the floor.You will need some sort of model where the correlation between the Fx rate and the interest rate (which can be large) is specified.