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CFA Level I · CFA Level I Exam · Forward Commitment and Contingent Claim Features and Instruments

A fund manager expects to invest cash in floating-rate deposits and wants protection against falling rates while keeping the benefit if rates rise. The instrument most appropriate for this purpose is:

A long interest rate floor is most appropriate. It pays when the floating rate falls below the strike, compensating the investor for lower deposit income, while the investor still benefits from higher rates, paying only the upfront premium for the protection.

  1. Aa long position in an interest rate floorCorrect
  2. Ba short position in an interest rate cap
  3. Ca pay-fixed position in a forward rate agreement

Explanation

A floor is a series of interest rate put options paying when the reference rate falls below the strike, so a long floor protects a floating-rate lender or investor while keeping upside from higher rates. A short cap would add obligations when rates rise. A pay-fixed FRA gains when rates rise and loses when they fall, the opposite of the need.

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