At the same time, the buyer of an IRO can enjoy the benefits of the interest rate staying below if she is a borrower or staying above if she is a lender the specified level.

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An IRO does NOT have an implied commitment by either counterparty to exchange the notional principal at any stage — so no credit has to be given no debt security purchased or deposit accepted debt security sold by either party. This also means that an IRO can be entered into with a pure speculation objective, rather than only with a view to hedge against adverse interest rate movements. A swaption gives the buyer an option to enter into an interest rate swap deal at a future date at a pre-agreed price.

What Are Vanilla Options?

A swaption gives the holder the benefit of the agreed strike rate fixed rate if the prevailing market swap rate fixed rate to be paid for receiving same benchmark floating rate is higher, while giving her the flexibility to enter into the prevailing market swap rate fixed rate to be paid , if it is lower than the strike rate. This benefits the holder if the prevailing market swap rate fixed rate to be received against the same benchmark floating rate to be paid is lower than the strike rate — in this scenario, the holder will exercise the swaption and enter into a swap whereby she receives the strike rate as the fixed rate.

If the reverse happens, she will not exercise the swaption and enter into a swap at the prevailing market swap rate.

Physically Settled — where the counterparties are obliged to enter into an interest rate swap deal on exercise of the swaption. Cash Settled — where the counterparties are only expected to exchange money on exercise of the swaption. There is no perfect way of doing things here.

FX Options and Smile Risk by

In particular, it is shown that using atm vols both fx and equity for the quanto adjustment and vol strike for the Black-Scholes formula leads to reasonable results. Finally, a more sophisticated adjustment is to use a manufactured vol based on the distribution of FX and Equity processes such as in the paper Quanto Implied Volatility Smile.

The correlation is mainly calibrated onto historical values since implied correlation is not really accessible. Sign up to join this community.

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Pricing and hedging of FX plain vanilla options

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Viewed 3k times. Improve this question. ZRH 1, 5 5 silver badges 18 18 bronze badges. This book is a unique guide to running an FX options book fromthe market maker perspective. Striking a balance betweenmathematical rigour and market practice and written by experiencedpractitioner Antonio Castagna, the book shows readers how tocorrectly build an entire volatility surface from the market pricesof the main structures. Starting with the basic conventions related to the main FX dealsand the basic traded structures of FX options, the book graduallyintroduces the main tools to cope with the FX volatility risk.

Itthen goes on to review the main concepts of option pricing theoryand their application within a Black-Scholes economy and astochastic volatility environment.