CMA Final · Strategic Financial Management · Interest Rate Derivatives
Kaveri Power has a floating-rate borrowing of ₹20 crore and buys an interest rate cap with a strike of 8% p.a. on a notional principal of ₹20 crore. Resets are quarterly. At one reset date the reference rate is 9.2% p.a. What is the cap payoff for that quarter?
The cap payoff is ₹6,00,000. The reference rate exceeds the strike by 1.2%, and applying this to ₹20 crore for one quarter gives 20 crore × 1.2% × 0.25. The cap pays only the excess over the strike, not the full rate.
- A₹6,00,000Correct
- B₹24,00,000
- C₹46,00,000
- D₹5,00,000
Explanation
Each caplet pays notional × max(reference rate − strike, 0) × period. This is 20,00,00,000 × (0.092 − 0.08) × 0.25 = 20,00,00,000 × 0.012 × 0.25 = ₹6,00,000. ₹24,00,000 is the annual amount and forgets the quarterly fraction. ₹46,00,000 uses the whole 9.2% rate instead of the excess over the strike.
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