ACCA Financial Management (F9) Certification Practice Exam

Which financial instrument sets a maximum interest rate on a loan or investment?

1. Interest rate collar

2. Interest rate cap

3. Interest rate floor

4. Interest rate futures

The correct answer is: Interest rate cap

The correct choice is the option that refers to an interest rate cap. An interest rate cap is a financial instrument specifically designed to limit the maximum interest rate that can be charged on a loan or received on an investment. This means that if market interest rates rise above a predetermined level, the cap ensures that the rate payable remains at or below this limit, providing protection for the borrower or investor from rising rates. This instrument is particularly useful for individuals or companies who want to mitigate the risk associated with rising interest rates. It provides certainty regarding maximum interest expenditure while still allowing for benefits if interest rates fall. In contrast, other instruments like an interest rate collar would involve combinations of caps and floors to establish a range within which interest rates may fluctuate. An interest rate floor provides a minimum interest rate rather than a maximum, ensuring that the interest received does not fall below a certain level. Interest rate futures are standardized contracts that obligate the buyer or seller to purchase or sell a financial instrument at a predetermined future date and price, but they do not specifically limit interest rates. Understanding these distinctions is key in financial management, especially when making decisions related to interest rate risks.