# Pricing a 1-year OTM caplet with 1-year tenor

Hi all,

I am trying to price and assess the impact on 1-year adjustable-rate mortgage bonds due to a new regulation that implements a short position in a 1-year caplet for the investor. The mortgage bond is extended by 1 year in case the interest rate on the ARM bond increase by more than 5 percantage point since last refinancing (I know the likelihood is very little).

Say, the rate is 1% at a given refinancing. At the next refinancing it is 7%. The bond is extended and the short position in the caplet [max(7%-(1+5%)] implies an interest rate to the bond investor for the extended year of 6%.

To price this caplet I want the volatility of the forward rate and I just want to look at e.g. EURIBOR to get an idea of the likelihood of a 5% increase from market data. I have access to Bloomberg and used the functions < VCUB > and < VOLS > to find relevant data, but it seems I cannot retrieve data on caplet volatilities of 1-year tenor.

I plan to use the above data in Black's Model and possibly SABR Model to arrive at a premium for a strike there is +5% the previous 12m EURIBOR.

So basically I need to:

1a) Find a relevant caplet volatility that resets in 1 year and pays in 2 years.

OR

1b) Alternatively I can maybe find the caplet volatility of a caplet resetting in 1 year and based on the 6m EURIBOR and then use methods to estimate the volatility of the 12m EURIBOR forward - Maybe I can use this article? http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2204702
In < VCUB > I change the 'Strike' dropdown to 'Tenor' and change the tenor to 6MO to get a grid of caplet volatilities. Are these correct for the purpose? (see picture)

2) The volatilites in < VCUB > are only stated for 4%, 5%, ..., 14%. Thus, I need to interpolate to get a strike exactly 5 percentage point above the choosen strike. Which interpolation methods do you recommend in this case?

P.S.
Sorry for my english and for possible stupid questions. I have only had a few quant courses and have no experience with the market (i.e. knowing what is traded and what is not). I have read a lot on these forums, in books and articles but am stuck at this point so I hope you can help out.

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