A Bank Purchases a 3-Year, 6 Percent $5 Million Cap

question 125

Multiple Choice

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: $$\begin{array} { | l | c | c | c | c | } \hline \text { End of Year: } & 0 & 1 & 2 & 3 \\\hline \text { Cash Flow at end of year: } & - & - & \mathrm { x } & \mathrm { x } \\\hline\end{array}$$ Instead of a cap, if the bank had purchased a 3-year 6 percent floor and interest rates are 5 percent and 6 percent in years 2 and 3, respectively, what are the payoffs to the bank?

• A)The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3.
• B)The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3.
• C)The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3.
• D)The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3.
• E)The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3.

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Definitions:

Adjusted Trial Balance

A version of the trial balance that reflects account balances after adjustments, serving as the basis for preparing financial statements.

Time Period Assumption

An accounting principle that allows businesses to divide their activities into specific time periods, such as months, quarters, or years, for reporting purposes.