# Question: Swaps often contain caps or floors In this problem you

Swaps often contain caps or floors. In this problem, you are to construct an oil contract that has the following characteristics: The initial cost is zero. Then in each period, the buyer pays the market price of oil if it is between K1 and K2; otherwise, if S K2, the buyer pays K2 (there is a floor and a cap). Assume that K2 − K1= $2 and that oil volatility is 15%.

a. If there is a single settlement date in 1 year, what are K1 and K2?

b. If the swap settles quarterly for eight quarters, what are K1 and K2?

a. If there is a single settlement date in 1 year, what are K1 and K2?

b. If the swap settles quarterly for eight quarters, what are K1 and K2?

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