Question
23. In each of the following cases, indicate whether an interest rate cap, floor, collar, or reverse collar is an appropriate position for a hedge.
23. In each of the following cases, indicate whether an interest rate cap, floor, collar, or reverse collar is an appropriate position for a hedge. Recommend a specific position.
a. A bank loan customer wants to borrow at a fixed 8 percent rate and the bank only lends at floating rates.
c. Your bank owns adjustable-rate mortgages (ARMs) that are priced at three-month LIBOR plus 1 percent. There is an annual cap on the allowable rate increase equal to a maximum of 1 percent a year. Thus, if LIBOR rises by 3 percent, the bank can raise the ARM rate just 1 percent. How can the bank effectively remove this cap?
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