Answer Happy

What are caps? Under what circumstances would a FI buy a
cap? Under what circumstances would the buyer of a cap receive a
payoff?
A $ 100 million cap is available at a premium of 0.60
percent of face value.
A $ 100 million floor is also available at a premium of 0.65
percent of face value.
a. An FI has return on assets of 9 percent. How can they
use caps or floors to ensure a target margin of 2%?
b. If interest rates rise to 12 percent, what is the net
profit after?
c. If the Fl also sells (writes) a 4 percent floor, what are the
net savings if interest rates rise to 12 percent? What if they fall
to 2 percent?
d. What amount of floors should it sell in order to compensate
for its purchases of caps, given the above premiums?