If a company has floating-rate debt tied to dollar LIBOR and wants to eliminate the possibility that LIBOR will exceed a particular rate (but preserve the possibility the LIBOR could decline), which of the following instruments would it most likely use?
A) Interest rate future contract.
B) Forward rate agreement.
C) Interest rate cap.
D) Interest rate collar.
E) Interest rate swap.

Question

Quizplus · Accepted Answer

An interest rate cap is the most suitable instrument for a company looking to eliminate the possibility that LIBOR will exceed a specific rate while still benefiting if LIBOR declines. This is because an interest rate cap sets a maximum (cap) on the interest rate the company will pay, without eliminating the potential benefit of paying a lower interest rate if LIBOR falls.

If a Company Has Floating-Rate Debt Tied to Dollar LIBOR