Which of the following is true about cap and floor options?

A cap and a floor are types of interest rate derivatives that serve distinct purposes in managing interest rate risk. A cap is a financial derivative that sets a maximum interest rate level, allowing the holder to benefit when interest rates rise above a specified level. This is particularly useful for borrowers looking to protect against increasing borrowing costs. Conversely, a floor sets a minimum interest rate level, providing benefits when interest rates fall below that threshold, which is advantageous for lenders or investors who want to ensure a minimum return on their assets.

Therefore, the first statement accurately reflects the mechanics of how each instrument functions in response to movements in interest rates.

In contrast, the other statements do not correctly represent the nature of cap and floor options. The idea that both limit risk exposure equally does not hold true, as they serve different purposes in risk management. Additionally, describing a cap as a put option and a floor as a call option mischaracterizes their fundamental definitions in financial markets. Lastly, while both caps and floors may be traded in various markets, they are not primarily traded on stock exchanges; instead, they are typically over-the-counter (OTC) products. Thus, the correct statement highlights the distinct roles that caps and floors play in an interest rate environment.