Assume a firm has a floating-rate loan and purchases a 10 percent cap on that loan.As a result,the firm will receive payments equal to:
A).10 × Assets.
B).10 × Annual interest payment.
C)(LIBOR − .10)× Principal loan amount.
D)(LIBOR + .10)× Principal loan amount.
E).10 × Principal loan amount.

Question

Quizplus · Accepted Answer

A cap is a derivative that pays the buyer when the interest rate exceeds a certain level (the cap rate). In this case, if LIBOR (the floating interest rate) exceeds 10%, the firm will receive payments equal to the difference between the LIBOR rate and 10%, multiplied by the principal amount of the loan. This compensates the firm for the extra interest it has to pay on the loan beyond the 10% cap.

Assume a Firm Has a Floating-Rate Loan and Purchases a 10