PelatihA caplet with strike on a floating rate for a period of length pays at the end of the period, where is the rate fixed for that period. A cap is a strip of caplets on consecutive periods; a floor is the same strip of floorlets, each paying .
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Example 13.2 (A cap and a zero-cost collar)
On a flat 4% curve, a five-year cap at 4.5% on USD 100 million of an annual rate, with the first period already fixed, has four caplets fixing in one to four years. At a normal volatility of 100 basis points a year they are worth USD 182 874, 310 339, 401 400 and 470 709: USD 1.37 million in all, 137 basis points of notional. A floor at 3.5% is worth exactly the same, since the forward sits halfway between the strikes and the normal model is symmetric: the borrower who buys the cap and sells the floor pays nothing and keeps its rate between 3.5% and 4.5%.