Cap/Floor digital payout

[mboudiaf]

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

[mgratacos]

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

[h_mcallister]

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.

[h_mcallister]

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)

[briscocounty]

Has any progress been made to formailize the proposal for the digial Cap and floor proposal?

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