floorbynormal

Price floors using Normal or Bachelier pricing model

Syntax

[FloorPrice,Floorlets] = floorbynormal(RateSpec,Strike,Settle,Maturity,Volatility)

[FloorPrice,Floorlets] = floorbynormal(___,Name,Value)

Description

[FloorPrice,Floorlets] = floorbynormal(RateSpec,Strike,Settle,Maturity,Volatility) prices floors using the Normal (Bachelier) pricing model for negative rates. floorbynormal computes prices of vanilla floors and amortizing floors.

[FloorPrice,Floorlets] = floorbynormal(___,Name,Value) adds optional name-value pair arguments.

Examples

Price a Floor Using Normal Model for Negative Rates

Consider an investor who gets into a contract that floors the interest rate on a $100,000 loan at –.6% quarterly compounded for 3 months, starting on January 1, 2009. Assuming that on January 1, 2008 the zero rate is .69394% continuously compounded and the volatility is 20%, use this data to compute the floor price. First, calculate the RateSpec, and then use floorbynormal to compute the FloorPrice.

ValuationDate = 'Jan-01-2008';
EndDates ='April-01-2010';
Rates = 0.0069394;
Compounding = -1;
Basis = 1;

% calculate the RateSpec
RateSpec = intenvset('ValuationDate', ValuationDate, ...
'StartDates', ValuationDate,'EndDates', EndDates, ...
'Rates', Rates,'Compounding', Compounding,'Basis', Basis);

Settle = 'Jan-01-2009'; % floor starts in a year
Maturity = 'April-01-2009';
Volatility = 0.20;
FloorRate = -0.006;
FloorReset = 4;
Principal=100000;

FloorPrice = floorbynormal(RateSpec, FloorRate, Settle, Maturity, Volatility,...
'Reset',FloorReset,'ValuationDate',ValuationDate,'Principal', Principal,...
'Basis', Basis)

FloorPrice = 1.8212e+03

Price a Floor Using floorbynormal and Compare to floorbyblk

Define the RateSpec.

Settle = datenum('20-Jan-2016');
ZeroTimes = [.5 1 2 3 4 5 7 10 20 30]';
ZeroRates = [0.0052 0.0055 0.0061 0.0073 0.0094 0.0119 0.0168 0.0222 0.0293 0.0307]';
ZeroDates = datemnth(Settle,12*ZeroTimes);
RateSpec = intenvset('StartDate',Settle,'EndDates',ZeroDates,'Rates',ZeroRates)

RateSpec = struct with fields:
           FinObj: 'RateSpec'
      Compounding: 2
             Disc: [10x1 double]
            Rates: [10x1 double]
         EndTimes: [10x1 double]
       StartTimes: [10x1 double]
         EndDates: [10x1 double]
       StartDates: 736349
    ValuationDate: 736349
            Basis: 0
     EndMonthRule: 1

Define the floor instrument and price with floorbyblk.

ExerciseDate = datenum('20-Jan-2026');

[~,ParSwapRate] = swapbyzero(RateSpec,[NaN 0],Settle,ExerciseDate)

ParSwapRate = 0.0216

Strike = .01;
BlackVol = .3;
NormalVol = BlackVol*ParSwapRate;

Price = floorbyblk(RateSpec,Strike,Settle,ExerciseDate,BlackVol)

Price = 1.2297

Price the floor instrument using floorbynormal.

Price_Normal = floorbynormal(RateSpec,Strike,Settle,ExerciseDate,NormalVol)

Price_Normal = 1.9099

Price the floor instrument using floorbynormal for a negative strike.

 Price_Normal = floorbynormal(RateSpec,-.005,Settle,ExerciseDate,NormalVol)

Price_Normal = 0.0857

Input Arguments

RateSpec — Interest-rate term structure

structure

Interest-rate term structure (annualized and continuously compounded), specified by the RateSpec obtained from intenvset. For information on the interest-rate specification, see intenvset.

Data Types: struct

Strike — Rate at which floor is exercised

decimal

Rate at which floor is exercised, specified as a NINST-by-1 vector of decimal values.

Data Types: double

Settle — Settlement date for floor

serial date number | date character vector | datetime object | string object

Settlement date for the floor, specified as a NINST-by-1 vector of serial date numbers, date character vectors, datetime objects, or string objects.

Data Types: double | char | datetime | string

Maturity — Maturity date for floor

serial date number | date character vector | datetime object | string object

Maturity date for the floor, specified as a NINST-by-1 vector of serial date numbers, date character vectors, datetime objects, or string objects.

Data Types: double | char | datetime | string

Volatility — Normal volatilities values

numeric

Normal volatilities values, specified as a NINST-by-1 vector of numeric values.

For more information on the Normal model, see Work with Negative Interest Rates Using Functions.

Data Types: double

Name-Value Arguments

Specify optional pairs of arguments as Name1=Value1,...,NameN=ValueN, where Name is the argument name and Value is the corresponding value. Name-value arguments must appear after other arguments, but the order of the pairs does not matter.

Before R2021a, use commas to separate each name and value, and enclose Name in quotes.

Example: [FloorPrice,Floorlets] = floorbynormal(RateSpec,Strike,Settle,Maturity,Volatility,'Reset',CapReset,'Principal',100000,'Basis',7)

Reset — Reset frequency payment per year

1 (default) | numeric

Reset frequency payment per year, specified as the comma-separated pair consisting of 'Reset' and a NINST-by-1 vector.

Data Types: double

Principal — Notional principal amount

100 (default) | numeric

Notional principal amount, specified as the comma-separated pair consisting of 'Principal' and a NINST-by-1 vector or a NINST-by-1 cell array. Each element in the NINST-by-1 cell array is a NumDates-by-2 cell array, where the first column is dates, and the second column is the associated principal amount. The date indicates the last day that the principal value is valid.

Use Principal to pass a schedule to compute the price for an amortizing cap.

Data Types: double | cell

Basis — Day-count basis of instrument

0 (actual/actual) (default) | integer from 0 to 13

Day-count basis of instrument representing the basis used when annualizing the input forward rate, specified as the comma-separated pair consisting of 'Basis' and a NINST-by-1 vector of integers. Values are:

• 0 = actual/actual

• 1 = 30/360 (SIA)

• 2 = actual/360

• 3 = actual/365

• 4 = 30/360 (PSA)

• 5 = 30/360 (ISDA)

• 6 = 30/360 (European)

• 7 = actual/365 (Japanese)

• 8 = actual/actual (ICMA)

• 9 = actual/360 (ICMA)

• 10 = actual/365 (ICMA)

• 11 = 30/360E (ICMA)

• 12 = actual/365 (ISDA)

• 13 = BUS/252

For more information, see Basis.

Data Types: double

ValuationDate — Observation date of investment horizon

if ValuationDate is not specified, then Settle is used (default) | serial date number | date character vector | datetime object | string object

Observation date of the investment horizon, specified as the comma-separated pair consisting of 'ValuationDate' and a serial date number, date character vector, datetime object, or string array.

Data Types: double | char | datetime | string

ProjectionCurve — Rate curve used in generating future cash flows

if ProjectionCurve is not specified, then RateSpec is used both for discounting cash flows and projecting future cash flows (default) | structure

The rate curve to be used in projecting the future cash flows, specified as the comma-separated pair consisting of 'ProjectionCurve' and a rate curve structure. This structure must be created using intenvset. Use this optional input if the forward curve is different from the discount curve.

Data Types: struct

Output Arguments

FloorPrice — Expected price of floor

vector

Expected price of the floor, returned as a NINST-by-1 vector.

Floorlets — Floorlets

array

Floorlets, returned as a NINST-by-NCF array of caplets, padded with NaNs.

More About

Floor

A floor is a contract that includes a guarantee setting the minimum interest rate to be received by the holder, based on an otherwise floating interest rate.

The payoff for a floor is:

$$\max (FloorRate-CurrentRate,0)$$

Version History

Introduced in R2017a