Question

new home and you have six so fixed-rate loans are now very Suppose. Shampa just signed a purchase and sale agreement on a weeks to obtain a mortgage. Interest rates have been falling attractive. Shampa could lock in a fixed rate of 7% ( annual percentage rate) for 30 years. On the other hand, rates are falling, so Shampa is thinking about a 30-year variable-rate loan, which currently at 4.5% and which is tied to the six-month Treasury bill rate. A final mortgage option is a variable-rate loan that begins at 5% and cannot fall below 3% but that can increase by only as much as 2% per year up to a maximum of 11%. a) If you wanted to take advantage of a possible fall in rates but not assume the risk that rates would increase dramatically, which financing plan would you choose? b) What is the interest rate cap in this Question? What is the interest rate floor in this Question? dHow is an interest rate cap like buying insurance? How is she paying for this insurance

Answer 1

a) b) you would take the plan that begins with a variable rate of 5% and can't go above 11% Cap = 11% floor =3% An interest rate cap is like buying insurance because you still benefit from falling rates, but you will never have to pay an interest rate above 11% . You pay for that with a higher initial variable rate of 5% versus 4.5% d) Please comment if you have any doubt