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CMA Final · Strategic Financial Management · Interest Rate Derivatives

A bank sold an interest rate cap on ₹25 crore notional with a strike of 8% p.a., covering three consecutive half-yearly periods. The 6-month reference rate at the reset dates is 8.6%, 7.8% and 9.2% p.a. respectively, and each payoff is made at the end of its period. Ignoring discounting, what total payment does the bank make to the buyer?

The bank pays ₹2,25,000. A cap pays only for periods when the reference rate exceeds 8%: the first gives ₹75,000 and the third gives ₹1,50,000, while the second pays nothing because 7.8% is below the strike.

  1. A₹2,00,000
  2. B₹3,50,000Correct
  3. C₹2,25,000
  4. D₹4,50,000

Explanation

A cap pays only when the rate exceeds the strike, period by period. Period 1: 0.6% x 0.5 x 25 crore = ₹75,000. Period 2: rate below strike, zero. Period 3: 1.2% x 0.5 x 25 crore = ₹1,50,000. Total = ₹2,25,000. Hence correct is ₹2,25,000, and option index must match that value.

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