Cap/Floor Buyer/Seller stupid question interest, someone, question, buyer

rohitdoshi

Could someone please simplify to me who is exposed to counterparty risk (buyer/seller) on interest rate derivatives (caps/floors)?

Q#3, Reading 62

A: "Once a fee for the interest rate floor is paid, the seller of an interest rate floor is not exposed to counterparty risk. Only the seller, not the buyer, must perform."

My brain is so fried right now

Thanks

ppls

Perfect! Thanks for your help guys, and I'm hoping to see a vignette similar to joeshph213's on the exam.

bingbingliang

Buyer is buying the interest rate floor from the seller.

1) Seller sells the floor to the buyer for a premium
2) Interest falls lower than the floor, Buyer says to Seller, "hey you owe me the difference, cough it up."
3) Seller goes "wuh? You crazy, Do I know you?"
Buyer: "Dude, interest rate lower than the floor I bought from you, pay up <expletive>"
Seller: "Ohh~~ that's riigghht. Okok, let me go home and get it.. Wait here kk?" <changes cell phone and bolts town)
4) Buyer po'd that he got screwed the premium he paid for the floor.
5) Hence, "seller is not exposed to counterparty risk"



Edited 1 time(s). Last edit at Thursday, May 20, 2010 at 09:40PM by joseph213.