Capped Swap


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Interest Rate Capped Swap, Floored Swap and Valuation

1. Capped Swap and Floored Swap Introduction

A capped swap is an interest rate swap with an interest rate cap option where the floating rate of the swap is capped at a certain level while a floored swap is an interest rate swap with a floor option where the floating rate of the swap is floored at a certain level. Capped swaps or floored swaps limit the risk of the floating rate payer or receiver to adverse movements in interest rates.

A capped swap can be decomposed into a interest rate swap and a cap whereas a floored swap can be decomposed into a interest rate swap and a floor. Given the optionality, an up-front fee or premium has to be paid by the floating rate payer for a capped swap and an up-front fee or premium has to be paid by the floating rate receiver for a floored swap.

2. Capped Swap and Floored Swap Valuation

There are four types of capped or floored swap.

  • Capped payer swap
  • Capped receiver swap
  • Floored payer swap
  • Floored receiver swap

They can be decomposed as follows.

Interest rate capped and floored swap valuation in FinPricing

The present value of a fixed leg is given by

Pricing fixed leg of interest rate swap in FinPricing

The present value of a floating leg can be expressed as

Pricing floating leg of interest rate swap in FinPricing

The present value of a cap is given by

Interest rate cap valuation in FinPricing

The present value of a floor is given by

Interest rate floor valuation in FinPricing
4. More Details

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5. Related Topics