Does Empirical σ (Based on Past Realizations) Price Caps, flOors

question 8

Essay

Does empirical σ (based on past realizations) price caps, floors and swap- tions acurately? On average does it overprice or underprice these securi- ties?

---

Definitions:

Compounded Semi-annually

Interest that is calculated and added to the principal amount twice a year, leading to interest being earned on interest.

Strip Bond

A type of bond where the coupon payments have been separated from the principal, allowing them to be sold independently as zero-coupon bonds.

Discount Rate

The interest rate charged by central banks for loans to commercial banks or the rate used in discounted cash flow analysis to determine present value.

Issue Price

The price at which a new issue of securities (like stocks or bonds) is offered to the public by an issuer.