Accounting for Investments, Volume 2: Fixed Income Securities and Interest Rate Derivatives—A Practitioner's Guide

QUESTIONS

Theory questions

1. What is meant by a cap on an interest rate contract?

2. Can an interest rate cap contract be terminated before maturity? If so how will the termination fees be arrived at?

3. When does an interest rate cap become “in the money” and when does it become “out of the money”?

4. What are the two types of interest rate cap contracts? Which type of contract gives the buyer protection from an interest rate hike?

5. What are the significant events in the trade life cycle of an interest rate cap contract?

6. What are the benefits of an interest rate cap contract?

7. What are the risks associated with an interest rate cap contract?

Objective questions

1. Caps provide the entity with protection against _______ interest rate movements above the strike rate.

a) Favorable

b) Unfavorable

c) Comfortable

d) None of the above

2. In an interest rate cap contract, the amount of premium payable is determined by:

a) Interest rate volatility

b) Market rate of interest

c) Strike rate

d) All of the above

3. An interest rate cap may be used as a form of ___________ interest rate protection tool in times of uncertainty.

a) Long-term

b) Short-term

c) Medium-term

d) None of the above

4. The cost is ________ to the premium paid and theoretically like any other option contract the upward potential is ___________.

a) Limited/unlimited

b) Maximum/minimum

c) Lower/higher

d) None of the above

5. In a cap, the premium is not _______ by the seller of the contract in any circumstances. ...