If a firm purchases a cap at 10% this will:
A) limit the amount of borrowing to 10% of assets.
B) pay the firm 10% on their purchase.
C) pay the holder the LIBOR interest above 10%.
D) pay the holder the LIBOR interest below the 10%.

Question

Quizplus · Accepted Answer

A cap is a financial derivative that provides a hedge against rising interest rates. When a firm purchases a cap at 10%, it means that if the LIBOR (or any reference interest rate) exceeds 10%, the cap will pay the holder the difference between the actual interest rate and the cap rate (10%). This protects the firm from paying interest rates above the cap level.

If a Firm Purchases a Cap at 10% This Will