ACCA Financial Management (F9) Certification Practice Exam

In what scenario would a company sell an interest rate floor?

1. To increase the cost of borrowing

2. To obtain a premium from the sold option

3. To hedge against potential losses from high-interest rates

4. To encourage favorable interest rates from lenders

The correct answer is: To obtain a premium from the sold option

Selling an interest rate floor occurs when a company is looking to obtain a premium from the sold option. An interest rate floor is a financial derivative that provides the buyer protection against falling interest rates. When a company sells this type of instrument, it receives an upfront premium from the buyer for the rights associated with the floor. By selling the floor, the company is taking on the obligation to compensate the buyer if market interest rates fall below a predetermined level. The premium received can be beneficial for the seller, providing immediate cash inflow that can be utilized for various purposes, such as investing in projects or enhancing liquidity. In contrast, the other scenarios do not align with the typical motivations behind selling an interest rate floor. For instance, increasing the cost of borrowing is generally not a goal, as the sale of such options typically aims to generate income rather than influence borrowing costs directly. Similarly, while hedging against potential losses from high-interest rates might intuitively seem relevant, selling a floor does not serve that purpose; it is designed to protect against falling rates, rather than high rates. Encouraging favorable interest rates from lenders is also misaligned, as the sale of a floor is more about receiving a premium than about negotiating loan terms with lenders.