Hello Hope you are doing well. Page 15 of ch13 says: caplet = floorlet + value of swap where swap is an arrangement to receive floating and pay fixed.. I am unable to figure out that why the put call parity is justified when swap arrangement is above. Why it can't be other way around that is: caplet = floorlet + (pay floating and receive fixed) Please help me to understand the reason behind same, Regards Yogesh
Hi Yogesh, Think about the potential cashflows on each element: buyer of caplet receives payment if floating rate is higher than the strike rate buyer of floorlet receives payment if floating rate is below the strike rate holder of swap receives floating and pays fixed. Now look at the cashflows on each side of the equality, taking each of the following scenarios in turn: scenario 1 - floating rate > strike rate scenario 2 - floating rate < strike rate. Can you see the equality working in both scenarios? Try the same analysis for your alternative. Regards David
