Internal Design of MCHullWhiteCapFloorEngine

Overview

Using the Monte Carlo Simulation to estimate the value of Cap/Floor Contract. Here, we use Hull-White Model to describe short-term interest rate movement.

Interest rate cap is a contract in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price. Interest rate floor is a contract in which the buyer receives payments at the end of each period in which the interest rate is below the agreed strike price.

The payoff is calculated as follows:

payoff of interest cap = \(max(L-K, 0) * N * \alpha\)

payoff of interest floor = \(max(K-L, 0) * N * \alpha\)

Where \(K\) is the strike interest rate and \(L\) is the actual interest rate that apply to this period. :math: N is nomial value of cap/floor contract and :math: alpha is time fraction corresponding to this period.

Implementation

In Monte Carlo Framework, the path generator is specified with Hull-White model. For path pricer, it fetches the interest sequence from the input stream, calculates the payoff based on above formula and discounts it to time 0 for cap/floor price.