Hello everyone

Here I am again with another problematic question.

I cant seem to get my head around a FI question (Q15, R44) where they set the coupon in arrears and floor/cap it at a certain level. I can figure out the coupon payment for the nod at the top and the bottom but i can not understand the process for the node which lie in the middle.

To give you a little more insight, the question is of valuing a bond with embeded options with a life of 3 yrs. They have given IRs for yr1-yr3 (1 IR for yr 1, 2 for yr 2 and 3 for yr3) … I discounted the CFs of the last year by taking all the relevant cash flows and have the DR for each as well. For 1 year on i am left with 3 CFs but i’ve 2 discount rates. That is ok when i am discounting the cash flows but i dont know what to do with the coupon payments? Should i take an average?

I hope i was able to explain you the problem … if not then please look at the EOC question and help me … needless to say i’ll be grateful for the help!!!