A series of 1-year interest rate caplets for 4 years have values of $0.05,$0.07,$0.08,and $0.10,respectively.What is the value of a 3-year interest rate cap?

Question

Quizplus · Accepted Answer

A 3-year interest rate cap can be created with a combination of 1-year and 2-year interest rate caplets. Using the given values, we can calculate the value of a 2-year caplet by subtracting the values of the 1-year caplets that precede it:

$0.08 - $0.07 = $0.01

Similarly, the value of a 3-year caplet can be calculated by subtracting the values of the 1-year caplets that precede it:

$0.10 - $0.08 = $0.02

Therefore, the value of a 3-year interest rate cap is the sum of a 2-year caplet and a 1-year caplet:

$0.01 + $0.05 = $0.06

Adding this value to the value of the 2-year caplet:

$0.06 + $0.14 = $0.20

Therefore, the answer is C) $0.20.

A Series of 1-Year Interest Rate Caplets for 4 Years