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Question
A bank purchases a 3-year, 6 percent $5 million cap (call options on interest rates), where payments are paid or received at the end of year 2 and 3 as shown below:
In addition to purchasing the cap, if the bank also purchases a 3-year 6 percent floor and interest rates are 5 percent and 7 percent in years 2 and 3, respectively, what are the payoffs to the bank? Specifically, the bank will
A. receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3.
B. receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3.
C. receive $0 at the end of year 2 and pay $50,000 at the end of year 3.
D. receive $0 at the end of year 2 and receive $50,000 at the end of year 3.
E. receive $50,000 at the end of year 2 and pay $0 at the end of year 3.
Answer
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