Inflation-Indexed Caplets/Floorlets

Abstract

An Inflation-Indexed Caplet (IIC) is a call option on the inflation rate implied by the CPI index. Analogously, an Inflation-Indexed Floorlet (IIF) is a put option on the same inflation rate. In formulas, at time T_i, the IICF payoff is

$$ N\psi _i \left[ {\omega \left( {\frac{{I(T_i )}} {{I(T_{i - 1} )}} - 1 - \kappa } \right)} \right]^ + , $$

(17.1)

where k is the IICF strike, ψ_i is the contract year fraction for the interval [T_i−1, T _i ], N is the contract nominal value, and ω = 1 for a caplet and ω = −1 for a floorlet.