A regional bank negotiates the purchase of a one-year interest rate cap with a cap rate of 5.45 percent with a large bank. The option has a notional principle of $2 million and costs $3,400. In one year,interest rates are 6.33 percent. The regional bank's net profit,ignoring commissions and taxes,was

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The interest rate cap pays the regional bank the difference between the actual interest rate and the cap rate on the notional principal. The payment is (6.33% - 5.45%) * $2,000,000 = $17,600. After subtracting the cost of the cap ($3,400), the net profit is $17,600 - $3,400 = $14,200.

A Regional Bank Negotiates the Purchase of a One-Year Interest