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The great development of interest rate derivative securities
in the financial market makes its evaluation an important issue.
Traditional optionpricing theories and term structure theories
have disadvantages while evaluatingthe price of interest rate
options. Thus, new interest rate models rise becauseof demands.
This study applies three different term structure models on the
valuation ofthe cap embedded in Far East Textile''s #62
corporation bond, and sensitivity analyses are followed. These
models include Black, Derman, and Toy (1990), Heath, Jarrow, and
Morton (1992), and Ritchken and Sankarasubramanian (1992). The
study suggests an algorithm to speed up the trial-and-error
method to solve simultaneous equations in the BDT model, and
some solutions to the problems found in the RS model. The
conclusions of this study are presented as follows:I. The
valuing result of the BDT normal-distribution model is quite
tiny, while the result of other models are all zero. Two
reasons can explain this: 1. the cap rate is too high; 2.
the historical data show that the volatility of the index rate
is small, while the mean reversion speed is big.II. About
the comparisons of the three model: 1. the BDT model has
simple assumption, but is not easy to solve using trial-
and-error method; 2. the calculation of the HJM model is
extremely time-consuming, thus the model has almost no
practical value; 3. the calculation of the RS model is fast,
but it may not form a reconnecting interest rate lattice.
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