Suppose Libor Caps and Floors at the Same Strike Rate

question 1

Multiple Choice

Suppose Libor caps and floors at the same strike rate are unequal in price. Suppose that, ceteris paribus, there is a sudden increase in interest-rate volatility. Which of the following statements is valid?

• A) Caps and floors will increase in value, but caps will increase by more than floors.
• B) Caps and floors will increase by the same amount.
• C) Caps and floors will increase in value, but caps will increase by less than floors.
• D) There is insufficient information to determine the answer.

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Definitions:

Aggregate Supply Curve

Curve showing the level of real GDP produced at different price levels during a time period, ceteris paribus.

Maximum Output Level

The highest quantity of a good or service that can be produced efficiently with available resources and technology.

Profit Incentive

A profit incentive is a financial or material reward that motivates individuals or businesses to pursue certain actions or goals for economic gain.

Classical Theory

An economic theory that suggests that free markets operate under the laws of supply and demand and are self-regulating.