optemfloatbycir

Price embedded option on floating-rate note for Cox-Ingersoll-Ross interest-rate tree

Syntax

[Price,PriceTree] = optemfloatbycir(CIRTree,Spread,Settle,Maturity,OptSpec,Strike,ExerciseDates)

[Price,PriceTree] = optemfloatbycir(___,Name,Value)

Description

[Price,PriceTree] = optemfloatbycir(CIRTree,Spread,Settle,Maturity,OptSpec,Strike,ExerciseDates) prices embedded options on floating-rate notes from a Cox-Ingersoll-Ross (CIR) interest rate tree. optemfloatbycir computes prices of vanilla floating-rate notes with embedded options using a CIR++ model with the Nawalka-Beliaeva (NB) approach.

Note

Alternatively, you can use the OptionEmbeddedFloatBond object to price embedded options on floating-rate notes. For more information, see Get Started with Workflows Using Object-Based Framework for Pricing Financial Instruments.

[Price,PriceTree] = optemfloatbycir(___,Name,Value) adds optional name-value pair arguments.

Examples

Price European Callable Embedded Option for a Floating-Rate Note Using a CIR Interest-Rate Tree

Create a RateSpec using the intenvset function.

Rates = [0.035; 0.042147; 0.047345; 0.052707]; 
Dates = [datetime(2017,1,1) ; datetime(2018,1,1) ; datetime(2019,1,1) ; datetime(2020,1,1) ; datetime(2021,1,1)]; 
ValuationDate = datetime(2017,1,1); 
EndDates = Dates(2:end)'; 
Compounding = 1; 
RateSpec = intenvset('ValuationDate', ValuationDate, 'StartDates', ValuationDate, 'EndDates',EndDates,'Rates', Rates, 'Compounding', Compounding); 

Create a CIR tree.

NumPeriods = length(EndDates); 
Alpha = 0.03; 
Theta = 0.02;  
Sigma = 0.1;   
Settle = datetime(2017,1,1); 
Maturity = datetime(2020,1,1); 
CIRTimeSpec = cirtimespec(Settle, Maturity, 3); 
CIRVolSpec = cirvolspec(Sigma, Alpha, Theta); 

CIRT = cirtree(CIRVolSpec, RateSpec, CIRTimeSpec)

CIRT = struct with fields:
      FinObj: 'CIRFwdTree'
     VolSpec: [1×1 struct]
    TimeSpec: [1×1 struct]
    RateSpec: [1×1 struct]
        tObs: [0 1 2]
        dObs: [736696 737061 737426]
     FwdTree: {[1.0350]  [1.0790 1.0500 1.0298]  [1.1275 1.0887 1.0594 1.0390 1.0270]}
     Connect: {[3×1 double]  [3×3 double]}
       Probs: {[3×1 double]  [3×3 double]}

Define the floater instruments with the embedded call option.

Spread = 10;
Settle = datetime(2017,1,1);
Maturity =  [datetime(2019,1,1) ; datetime(2020,1,1)];
Period = 1;
OptSpec = {'call'};
Strike = 101;
ExerciseDates = datetime(2019,1,1);

Compute the price of the floaters with the embedded call.

[Price,PriceTree] = optemfloatbycir(CIRT,Spread,Settle,Maturity,OptSpec,Strike,ExerciseDates)

Price = 2×1

  100.1887
  100.2757

PriceTree = struct with fields:
    FinObj: 'CIRPriceTree'
      tObs: [0 1 2 3]
     PTree: {[2×1 double]  [2×3 double]  [2×5 double]  [2×5 double]}

Input Arguments

CIRTree — Interest-rate tree structure

structure

Interest-rate tree specified as a structure by using cirtree.

Data Types: struct

Spread — Number of basis points over the reference rate

nonnegative integer | vector of nonnegative integers

Number of basis points over the reference rate specified as a vector of nonnegative integers for the number of instruments (NINST-by-1).

Data Types: double

Settle — Settlement dates of floating-rate note

ValuationDate of CIR tree (default) | datetime array | string array | date character vector

Settlement dates of floating-rate note specified as a NINST-by-1 vector using a datetime array, string array, or date character vectors.

Note

The Settle date for every floating-rate note with an embedded option is set to the ValuationDate of the CIR tree. The floating-rate note argument Settle is ignored.

To support existing code, optemfloatbycir also accepts serial date numbers as inputs, but they are not recommended.

Maturity — Floating-rate note maturity date

datetime array | string array | date character vector

Floating-rate note maturity date specified as a NINST-by-1 vector using a datetime array, string array, or date character vectors.

To support existing code, optemfloatbycir also accepts serial date numbers as inputs, but they are not recommended.

OptSpec — Definition of option

character vector with value of 'call' or 'put' | cell array of character vectors with value of 'call' or 'put' | string array with value of "call" or "put"

Definition of option, specified as a NINST-by-1 cell array of character vectors or string arrays with a value of 'call' or 'put'.

Data Types: cell | char | string

Strike — Option strike price values

nonnegative integer | vector of nonnegative integers

Option strike price values specified nonnegative integers using as NINST-by-NSTRIKES vector of strike price values.

Data Types: double

ExerciseDates — Exercise date for option (European, Bermuda, or American)

datetime array | string array | date character vector

Exercise date for option (European, Bermuda, or American) specified as a NINST-by-NSTRIKES or an NINST-by-2 vector using a datetime array, string array, or date character vectors.

• For a European or Bermuda option, the ExerciseDates is a 1-by-1 (European) or 1-by-NSTRIKES (Bermuda) vector of exercise dates. For a European option, there is only one ExerciseDates on the option expiry date.

• For an American option, the ExerciseDates is a 1-by-2 vector of exercise date boundaries. The option exercises on any date between or including the pair of dates on that row. If there is only one non-NaN date, or if ExerciseDates is 1-by-1, the option exercises between the Settle date and the single listed ExerciseDates.

To support existing code, optemfloatbycir also accepts serial date numbers as inputs, but they are not recommended.

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: [Price,PriceTree] = optemfloatbycir(CIRTree,Spread,Settle,Maturity,OptSpec,Strike,ExerciseDates,'AmericanOpt',1,'FloatReset',6,'Basis',8)

AmericanOpt — Option type

scalar | vector of positive integers[0,1]

Option type, specified as the comma-separated pair consisting of 'AmericanOpt' and a NINST-by-1 vector of flags with values:

• 0 — European/Bermuda

• 1 — American

Data Types: double

FloatReset — Frequency of payments per year

1 (default) | positive integer from the set [1,2,3,4,6,12] | vector of positive integers from the set [1,2,3,4,6,12]

Frequency of payments per year, specified as the comma-separated pair consisting of 'FloatReset' and positive integers for the values [1,2,3,4,6,12] in a NINST-by-1 vector.

Note

Payments on floating-rate notes (FRNs) are determined by the effective interest-rate between reset dates. If the reset period for an FRN spans more than one tree level, calculating the payment becomes impossible due to the recombining nature of the tree. That is, the tree path connecting the two consecutive reset dates cannot be uniquely determined because there will be more than one possible path for connecting the two payment dates.

Data Types: double

Basis — Day-count basis of the instrument

0 (actual/actual) (default) | positive integers of the set [1...13] | vector of positive integers of the set [1...13]

Day-count basis of the instrument, specified as the comma-separated pair consisting of 'Basis' and a positive integer using a NINST-by-1 vector. The Basis value represents the basis used when annualizing the input forward-rate tree.

• 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

EndMonthRule — End-of-month rule flag

1 (in effect) (default) | nonnegative integer [0,1]

End-of-month rule flag, specified as the comma-separated pair consisting of 'EndMonthRule' and a nonnegative integer [0, 1] using a NINST-by-1 vector. This rule applies only when Maturity is an end-of-month date for a month having 30 or fewer days.

• 0 = Ignore rule, meaning that a bond coupon payment date is always the same numerical day of the month.

• 1 = Set rule on, meaning that a bond coupon payment date is always the last actual day of the month.

Data Types: double

Principal — Principal values

100 (default) | vector of nonnegative values | cell array of nonnegative values

Principal values, specified as the comma-separated pair consisting of 'Principal' and nonnegative values using a NINST-by-1 vector or NINST-by-1 cell array of notional principal amounts.

When using a NINST-by-1 cell array, each element is a NumDates-by-2 cell array where the first column is dates, and the second column is associated principal amount. The date indicates the last day that the principal value is valid.

Data Types: double | cell

Options — Structure containing derivatives pricing options

structure

Structure containing derivatives pricing options, specified as the comma-separated pair consisting of 'Options' and the output from derivset.

Data Types: struct

Output Arguments

Price — Expected prices of the floating-rate note option at time 0

scalar | vector

Expected prices of the floating-rate note option at time 0 are returned as a scalar or an NINST-by-1 vector.

PriceTree — Structure of trees containing vectors of option prices at each node

tree structure

Structure of trees containing vectors of instrument prices and accrued interest and a vector of observation times for each node returned as:

• PriceTree.tObs contains the observation times.

• PriceTree.PTree contains option prices.

More About

Floating-Rate Note with Embedded Options

A floating-rate note with an embedded option enables floating-rate notes to have early redemption features.

A FRN with an embedded option gives investors or issuers the option to retire the outstanding principal prior to maturity. An embedded call option gives the right to retire the note prior to the maturity date (callable floater), and an embedded put option gives the right to sell the note back at a specific price (puttable floater).

For more information, see Floating-Rate Note with Embedded Options.

References

[1] Cox, J., Ingersoll, J., and S. Ross. "A Theory of the Term Structure of Interest Rates." Econometrica. Vol. 53, 1985.

[2] Brigo, D. and F. Mercurio. Interest Rate Models - Theory and Practice. Springer Finance, 2006.

[3] Hirsa, A. Computational Methods in Finance. CRC Press, 2012.

[4] Nawalka, S., Soto, G., and N. Beliaeva. Dynamic Term Structure Modeling. Wiley, 2007.

[5] Nelson, D. and K. Ramaswamy. "Simple Binomial Processes as Diffusion Approximations in Financial Models." The Review of Financial Studies. Vol 3. 1990, pp. 393–430.

Version History

Introduced in R2018a

R2022b: Serial date numbers not recommended

Although optemfloatbycir supports serial date numbers, datetime values are recommended instead. The datetime data type provides flexible date and time formats, storage out to nanosecond precision, and properties to account for time zones and daylight saving time.

To convert serial date numbers or text to datetime values, use the datetime function. For example:

t = datetime(738427.656845093,"ConvertFrom","datenum");
y = year(t)

y =

        2021

There are no plans to remove support for serial date number inputs.