1) An interest rate cap: 2) The buyer of a put option agrees to: 3) The seller o

Question

1) An interest rate cap:

2) The buyer of a put option agrees to:

3)The seller of a call option obligates themselves to:

4) A bank has long-term fixed rate loans that are funded with short-term CDs. Which of the following transactions could lower the bank’s interest rate risk?

A) obligates both parties to trade at a preset price at a future date B) gives one party the right to buy an underlying good in the future at a preset price C) gives one party the right to sell an underlying good in the future at a preset price D) sets the maximum interest rate paid/received E) none of the above

Explanation / Answer

1) Option D is correct ie sets the maximum interest rate paid/recd.

Reason : Cap is termed as ceiling of interest rate so to protect from fluctuations of interest rate the interest rate cap is provided.

2) Option D is correct.

Reason : Buyer of a put option means that a seller has agreed to decide later whether to ssell the underlying goods at present price in future, because put option meand right to sell an option and buyer to such option means he has right to sell the option he has purchased.

3) Option C is correct.

Reason is vice versa as given in Question 2 above.

4) Option B is correct.

Reason : If bank relies more on funding of long term with short term deposits than in such case bank will pay short term variable rate and recieve a fixed rate of interest to cover the interest risk exposure.

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