Final answer:
The correct answer to the question is option B: Cap. In a cap agreement, the writer makes payments when LIBOR exceeds the striking rate, serving as insurance against rising interest rates.
Step-by-step explanation:
The question refers to a specific type of financial instrument that is used to manage interest rate exposure known as 'derivatives'. Among the various types of derivative instruments, the Cap agreement is the one where the writer, or seller, of the agreement makes settlement payments when the London Interbank Offered Rate (LIBOR) exceeds a predetermined level known as the striking rate.
While a swap agreement is an arrangement to exchange financial instruments, a floor agreement is its opposite, where a payment is made when LIBOR falls below the striking rate. A collar is a combination of a cap and a floor. It limits the range of possible interest rate movements to a specified range.
Put simply, a cap agreement is essentially insurance against rising interest rates. The purchaser of a cap pays a premium for the right to receive payments if interest rates exceed a certain threshold (the striking rate), which can help manage or 'cap' their interest rate risk. If LIBOR rises above the striking rate, the writer of the cap must make payments to the purchaser, compensating them for the higher than expected interest rates. Therefore, the correct option in this context is option B: Cap.