In the flexi cap considered in Section 29.2 the holder is obligated to exercise the first N in-the-money caplets. After that no further caplets can be exercised. (In the example, N=5.) Two other ways that flexi caps are sometimes defined are:

(a) The holder can choose whether any caplet is exercised, but there is a limit of N on the total number of caplets that can be exercised.

(b) Once the holder chooses to exercise a caplet all subsequent in-the-money caplets must be exercised up to a maximum of N. Discuss the problems in valuing these types of flexi caps. Of the three types of flexi caps, which would you expect to be most expensive? Which would you expect to be least expensive?

AppendixLO1