An agreement obligating the seller to effect cash settlement to the buyer if the specified underlying interest exceeds a predetermined level of performance is known as:

Question

Options

• ACap
• BCapital
• CExcess
• DDissipation

• A
  82% (28)
• B
  6% (2)
• C
  9% (3)
• D
  3% (1)

Explanation

A Cap is a derivative agreement where the seller pays the buyer whenever a reference rate (like an interest rate) rises above a specified "cap rate." It protects the buyer against rates exceeding a ceiling, with cash settlement triggered each time the underlying interest surpasses the predetermined level.

• B. Capital refers to financial assets or funds, not a derivative instrument - it has no built-in settlement mechanism tied to performance thresholds.
• C. Excess is a general term describing an amount beyond a limit; it's not a recognized financial instrument with obligatory settlement terms.
• D. Dissipation means the wasting or dispersal of assets and has no relevance to derivative contracts.

Memory tip: Think of a cap as a ceiling - just as a physical cap sits on top of something, a cap agreement puts a ceiling on exposure, and the seller compensates the buyer whenever rates punch through that ceiling.

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