Summary

This chapter was about interest rate models and interest rate derivatives. After introducing the Black model, we used it to price caps and caplets. We also examined the R code for the Black-Scholes model.

Then, we turned our attention to interest rate models such as the Vasicek and CIR models. We discussed the theory of parameter estimation as well. At the end, we briefly demonstrated how the SMFI5 package works. Interest rate models were important for us in this chapter because the pricing of interest rate derivatives starts with assuming something about interest rates and yield curves in the future. With the help of a properly chosen and calibrated model, we have the opportunity to analyze possible future scenarios of the interest rates. Interest rate models are, of course, a much wider topic, which is worth studying in more detail. However, learning the most popular and well-known models is a good start, and we encourage you to study them further or check out the next chapter because...