Cap risk - Schweser pro

CFA Level III Fixed Income
#1

Dear all,

Can anyone please help me understand how the answer for the below question could be logically correct.

Question ID#: 92162

Which of the following is the best definition of cap risk? Cap risk is the risk:

A) that the funding rate used to purchase a floating rate note exceeds the note’s cap rate.

B) associated with the issuer of a floating rate note with an embedded cap.

C) that a floating rate note has an embedded cap.

The correct answer was A.

Cap risk is the risk that the cost of the firm’s interest rate-sensitive liabilities exceeds the return on its capped assets in an environment of rising interst rates. Cap risk is a particular concern to investors who borrow at a floating rate

Thank you

#2

Hello,

I’ve done more than 40% of the Schweser qbank 2014 and some questions let me very confused. I remember this one, I understood like this:

  • Buy floating rate note with a cap (let say, 5%)

  • You buy the floating rate note with debt (floated)

  • When interest rates increase (above 5%) you will pay more than 5% on the debt but receive 5% from the note…

Some questions are totally weird!

#3

Hi yqb_cdg,

Yes I agree it is confusing. I have another question in the forum which is not in sync with the text.

Thank you for letting me know.

Good luck on your exam.