Hi,

does any one know how to set up a digital payout in an interest rate cap/floor?

In vanilla cap : payoff = r-K if r >K
In digital cap : payoff = r' if r > K where r' is a user input.

thanks
Miloud

Dear Miloud,

I don't think FpML supports digital payouts on caps/floors. However, I'd think that only a simple extension with a an element to indicate that the payout is digital would be necessary in this case since the additionalPayment structures would allow you to represent the r'

Best regards,
Marc

I think that the suggestion of using additionalPayment does not work, because the additionalPayments are deterministic - the cashflow will occur with specified magnitude on the specified date - whereas the option payoff is contingent on attaining the strike - this fact is unknown until the fixing. Second, a cap/floor digital payoff is usually expressed as a rate, applied to the notional for the applicable coverage (duration) and day-count convention, and this is not supported by a "payment" representation.

Philip Leach at DTCC recently produced a propoal on digital cap/floors (see FpML Issue #900) and I have been working on a response.

I have produced a proposal on support for digital cap/floors in FpML - please see materials contained in DigitalCapFloorProposal.BNPParibas.zip, attached to FpML Issue #900 (http://www.fpml.org/issues/view.php?id=900)