A bank enters into an agreement to cap 2-month LIBOR for 2years. The cap rate is 5.5% per annum and the notional amount is $1 million. Assume the discount rate and forward LIBOR for all maturities is flat at 5% per annum continuously compounded.

Q: Value the cap as a portfolio of caplets. You may assume the volatility of the forward interest rates is 20% for all maturities.

A bank enters into an agreement to cap 2-month LIBOR for 2 years. The cap rate is 5.5% per annum and the notional amount is $1 million. Assume the discount rate and forward LIBOR for all maturities is flat at 5% per annum continuously compounded. + a) Explain why a cap can be valued as a portfolio of options on an interest rate. Type answer here b) Value the cap as a portfolio of caplets. You may assume the volatility of the forward interest rates is 20% for all maturities. A bank enters into an agreement to cap 2-month LIBOR for 2 years. The cap rate is 5.5% per annum and the notional amount is $1 million. Assume the discount rate and forward LIBOR for all maturities is flat at 5% per annum continuously compounded. + a) Explain why a cap can be valued as a portfolio of options on an interest rate. Type answer here b) Value the cap as a portfolio of caplets. You may assume the volatility of the forward interest rates is 20% for all maturities