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 these.

Question

Quizplus · Accepted Answer

A cap is a derivative product used to protect against the upward movement of interest rates. In this case, if the firm purchases a cap at 10%, it means they will receive payments if LIBOR exceeds 10%. Therefore, the correct answer is C - the holder will receive the LIBOR interest above 10%.

If a Firm Purchases a Cap at 10% This Will