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Published: 12th August 2014 by William Webster
Interest rate caps are a string of options on forward starting Libor. The individual option is called a “caplet” with the combined sum of each caplet’s value giving the cap price or premium.
Forward interest rates are calculated from the par yield curve. To help understand them a simple example helps.
If you borrow money for six months and deposit it for three months there is a rate of interest that you need to receive on your deposit between month three and month six in order to give you sufficient cash to repay your initial borrowing with interest. This is the breakeven or forward rate:
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14th October 2009
Gap reports show you the interest rate risk you are running in your balance sheet. They put the assets and liabilities into time buckets in accordance with their interest rate repricing. From this simple approach you can obtain a table or graph of the risk being run. This normally includes a profit and loss figure that results from moving the yield curve. Gap limits are also applied in order to keep the interest rate exposure within risk tolerence. Gap reports aren't new; they are widely used and have both strengths and weaknesses. Let's find out more.