Target Redemption Notes

The target redemption note is an index linked note that provides a guaranteed sum of coupons (target cap) with the possibility of early termination. In a typical structure, the coupons are calculated based on an inverse floating LIBOR / Euribor formula. Once the accumulated amount of coupons has reached the pre-specified target cap, the note will be terminated with final payment of the par. The knock-out criterion depends on a path dependent state variable defined by the running accumulated coupon sum. In some simplified cases, we manage to obtain a closed form valuation formula for the note value. We propose several numerical schemes for pricing the note under the one-factor and two-factor short rate models. Pricing behaviors of the target redemption note are also explored.