A client is interested in buying a cap on interest rates to protect their assets against rising interest rates. The cap they are looking at is an option that expires in 5 years. It can only be exercised at the end of 5 years - that is, it is European style. The underlying rate that it is based upon in the 10-year United States Treasury rate. Its strike is 4%. So, for 100mm in notional, its payoff will be 100mm x max (10-year Treasury - 4%,0). IE, 5% rates will pay off 1mm. The cost is 3 bps (= $30,000). Use the option model techniques we have discussed in evaluating this. Use both an inside and outside view to assess whether this is good value. By good value, is the expected payoff> the cost? A client is interested in buying a cap on interest rates to protect their assets against rising interest rates. The cap they are looking at is an option that expires in 5 years. It can only be exercised at the end of 5 years - that is, it is European style. The underlying rate that it is based upon in the 10-year United States Treasury rate. Its strike is 4%. So, for 100mm in notional, its payoff will be 100mm x max (10-year Treasury - 4%,0). IE, 5% rates will pay off 1mm. The cost is 3 bps (= $30,000). Use the option model techniques we have discussed in evaluating this. Use both an inside and outside view to assess whether this is good value. By good value, is the expected payoff> the cost