A Bank Purchases a 3-Year, 6 Percent $5 Million Cap

Multiple Choice

A bank purchases a 3-year, 6 percent $5 million cap (call options on interest rates) , where payments are paid or received at the end of year 2 and 3 as shown below: $$\begin{array} { | l | c | c | c | c | } \hline \text { End of Year: } & 0 & 1 & 2 & 3 \\\hline \text { Cash Flow at end of year: } & - & - & \mathrm { x } & \mathrm { x } \\\hline\end{array}$$ Instead of a cap, if the bank had purchased a 3-year 6 percent floor and interest rates are 5 percent and 6 percent in years 2 and 3, respectively, what are the payoffs to the bank?

A) The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3.
B) The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3.
C) The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3.
D) The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3.
E) The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3.