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CMA Final · Strategic Financial Management · Interest Rate Derivatives

Sundaram Textiles buys an interest rate cap on a notional principal of ₹10 crore with a strike rate of 7% p.a. The cap settles every six months. On one reset date the reference rate is 8.2% p.a. What is the cap payoff receivable for that six-month period, ignoring the premium?

The cap payoff is ₹6,00,000. A cap pays the notional times the excess of the reference rate over the strike, scaled for the period. Here the excess is 1.2%, so ₹10 crore × 1.2% × half a year gives ₹6,00,000. Using a full year would double it wrongly.

  1. A₹6,00,000Correct
  2. B₹12,00,000
  3. C₹35,00,000
  4. D₹41,00,000

Explanation

The payoff is notional × (reference rate − strike) × period = 10,00,00,000 × (8.2% − 7%) × 6/12 = 10,00,00,000 × 0.012 × 0.5 = ₹6,00,000. ₹12,00,000 is wrong because it uses a full year instead of half a year. ₹35,00,000 and ₹41,00,000 are wrong because they apply the strike or the reference rate to the whole notional instead of the excess over the strike.

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