Reading 55 - Interest Rate Derivative Instruments Flashcards
What is an interest rate cap?
**Critical Concept**
An agreement in which one party agrees to pay the other at regular intervals over a certain period of time when the benchmark interest rate exceeds the strike rate specified in the contract.
The buyer of a cap is similar to that of a _______?
The buyer of a call option
** this is b/c the buyer only gets paid if rates rise and exceed the cap strike.
What is an interest rate floor?
An agreement in which one party agrees to pay the other at regular intervals over a certain time period when the benchmark interest rate falls below the strike rate in the contract.
The buyer of a interest rate floor has a position similar to ________?
The buyer of a put on LIBOR.
***benefits when interest rates fall below the strike price.
What is the formula to calculate the payoff to a floating rate cap buyer?
What is the formula to calculate the payoff to the floor buyer?
What is an interest rate collar?
A simultaneous position in a floor and a cap on the same benchmark rate over the same period with the same settlement dates.
What are the two types of interest rate collars?
- To purchase a cap and sell a floor
- To purchase a floor and sell a cap.
