A Five-Year Cap Is Reset Annually Period

question 4

Multiple Choice

A five-year cap is reset annually period. The cap rate is 3% and the notional principal is $100 million. The 12-month LIBOR interest rate for the third year proves to be 5%. Which of the following is approximately true?

• A) The resulting payoff is $2 million at the beginning of the third year
• B) The resulting payoff is $2 million at the end of the fifth year
• C) The resulting payoff is $2 million at the end of the third year
• D) The resulting payoff is $2 million half way through the third year

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Definitions:

Pre-contractual Problem

Issues that arise before a contract is finalized, often related to information asymmetry or negotiating terms.

Post-contractual Problem

Issues or disputes that arise after a contract has been signed and during its execution period.

Agency Costs

Costs incurred in principal–agent relationships; these costs are associated with moral hazard and adverse selection problems.

Adverse Selection

A situation in economics and insurance where the party on one side of the deal has more information than the party on the other side, leading to an imbalance and potentially unfair outcomes.