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CMA Final · Strategic Financial Management · Interest Rate Derivatives

A company wants protection against a rise in its floating borrowing rate and buys an interest rate cap with strike 8% on notional Rs 5 crore, with quarterly resets. At one reset date the reference rate is 9.2% p.a. Taking a quarter as one-fourth of a year, what is the payoff received for that period?

The payoff is Rs 1,50,000. A cap pays the excess of the reference rate over the strike, here 1.2%, on the notional of Rs 5 crore for one quarter. That gives 5,00,00,000 x 1.2% x 1/4 equal to Rs 1,50,000.

  1. ARs 1,50,000Correct
  2. BRs 6,00,000
  3. CRs 4,60,000
  4. DRs 0

Explanation

Cap payoff = notional x max(0, rate - strike) x 1/4 = 5,00,00,000 x 1.2% x 0.25 = Rs 1,50,000. Rs 6,00,000 omits the quarter fraction; Rs 4,60,000 uses the full rate rather than the excess over strike.

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