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CMA Final · Strategic Financial Management · Interest Rate Derivatives

A company has a floating-rate borrowing and buys an interest rate cap with a strike of 8% on a notional principal of Rs 10 crore. On a reset date, the reference rate for a six-month period is 9.5% per annum. Ignoring the premium, what is the payoff received by the company for that period?

The cap pays on the excess of the reference rate over the strike for the period. The excess is 1.5% per annum, applied to Rs 10 crore for half a year, giving Rs 7.5 lakh. Using the full year would double the payoff incorrectly.

  1. ARs 7.5 lakhCorrect
  2. BRs 15 lakh
  3. CRs 9.5 lakh
  4. DRs 0

Explanation

Cap payoff = notional x (reference rate - strike) x period = 10 crore x (9.5% - 8%) x 6/12 = 10,00,00,000 x 0.015 x 0.5 = Rs 7.5 lakh. Rs 15 lakh is wrong because it ignores the half-year fraction and uses the annual rate difference.

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