A thrift purchases a one-year interest rate floor with a floor rate of 4.23 percent from a large bank. The option has a notional principal of $1 million and costs $2,000. If in one year,interest rates are 3 percent,the thrift's net profit,ignoring commissions and taxes,was _____ ; and if in one year,interest rates were 2 percent,the thrift's net profit was _____.

Question

Quizplus · Accepted Answer

The thrift's net profit is the difference between the floor rate and the market rate, multiplied by the notional principal. If interest rates are 3%, the thrift's net profit is (4.23% - 3%) * $1 million = $8,800. If interest rates are 2%, the thrift's net profit is (4.23% - 2%) * $1 million = $29,500.

A Thrift Purchases a One-Year Interest Rate Floor with a Floor