# Int Rate Cap

Is this correct? I thought the payments for a rate cap would be determined by the current rates on the dates of the settlement… (in this case, 4.5 and 4…) A firm purchases a one-year cap with a strike rate of 4%, a notional principal of \$3 million, and semiannual settlement. The reference rate at the initiation of the cap is 5%, falls to 4.5% at the next settlement and then to 4% one year after the cap’s initiation. The total payoffs (without discounting) over the maturity of the swap would be: A) \$22,792. B) \$25,500. C) \$7,583. Your answer: B was incorrect. The correct answer was A) 22,792. Since the number of days is not given for each period, approximate it with 182 in the first period and 183 in the second period. Remember that payments are made in arrears. First payoff = 15,167 = \$3,000,000 × max(0, 0.05 – 0.04) × (182/360). Second payoff = \$7,625 = \$3,000,000 × max(0, 0.045 – 0.04) × (183/360) Total = \$22,792 = 7,625 + 15,167

yes this is correct. for caps and floors, rates are determined in arrears … i.e. if its a semi-annual pay cap, rates on Jan 1 will detmine the payoff on June 30 and rates on July 1 will determine the payoff on Dec 31.