quanto caplet is a contract that pays at
an amount proportional
to
units of dollar. The
is the
-Libor.
Hence, from the $ point of view, the value of the contract
is
The
is a martingale with respect to the
-measure:
We wish to transform to the
-measure.
Hence, we use the (
Change of
numeraire
recipe
)
The combination under the log-sign is the forward exchange rate
(
Forward exchange rate
) for the time
as observed at
Therefore,
Similarly to the previous section we now construct a martingale combination
and observe that the price of the contract is given by the Black-Scholes type
formula.
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