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

Question

Quizplus · Accepted Answer

Using the formula, we can calculate the thrift's net profit as follows:
- If interest rates are 3%, the actual rate is lower than the floor rate, so the option is in the money. The profit is ((4.23% - 3%) x $1 million) - $2,000 = $8,800.
- If interest rates are 2%, the actual rate is lower than the floor rate, so the option is in the money. However, the profit is limited to $0 because the option payout cannot be negative.
Therefore, the best choice is C, with a net profit of $8,800 if interest rates are 3%, and $0 if interest rates are 2%.

A Thrift Purchases a 1-Year Interest Rate Floor with a Floor