If a ﬁrm purchases a cap at 10% this will:
A)limit the amount of borrowing to 10% of assets.
B)pay the ﬁrm 10% on their purchase.
C)pay the holder the LIBOR interest above 10%.
D)pay the holder the LIBOR interest below the 10%.
E)None of the above.

Question

Quizplus · Accepted Answer

A cap is a financial contract that provides the holder with a maximum interest rate on a floating rate loan. If a firm purchases a cap at 10%, it means that the cap holder will receive the difference between the prevailing LIBOR interest rate and 10%. In other words, the cap holder will receive payments whenever the LIBOR interest rate is above 10%.

If a ﬁRm Purchases a Cap at 10% This Will