CAPS AND OPTIONS THE DANGEROUS NEW PROTECTION RACKET
It's too late now to stop them and ask what they think they're doing. The latest fad in the market is up and running. The new product is glistening on every shelf: the interest-rate cap.
The investment bank superbrains have grown bored with the monotony of swaps which they invented as long as five years ago and which have now become a mere commodity. Goaded also by fears of redundancy or a cutback in their remunerations they had to come up with something else.
The demand for caps is fed by fears of volatility. US dollar interest rates are on a downward trend, but what if they went up? Are you protected? Swaps can give you that protection, if you swap into fixed-rate debt. But with a swap you can't take advantage of falling interest rates. The cap gives treasurers that advantage but also protects them if interest rates should rise above, say, 12%. It protects industrial and real estate companies against unforeseen borrowing costs. It allows market players to fund medium-term portfolios with short-term money knowing that they are protected if short-term rates go up.