Question

An FI has purchased a $202 million cap of 9 percent at a premium of 0.75 percent of face value. A $202 million floor of 4.2 percent is also available at a premium of .80 percent of face value.

a. If interest rates rise to 10 percent, what is the amount received by the FI? What are the net savings after deducting the premium?
b. If the FI also purchases a floor, what are the net savings if interest rates rise to 11 percent? What are the net savings if interest rates fall to 3.2 percent? (Negative amounts should be indicated by a minus sign.)
c. If, instead, the FI sells (writes) the floor, what are the net savings if interest rates rise to 11 percent? What if they fall to 3.2 percent? (Negative amounts should be indicated by a minus sign.)
  

	a. Amount received Net savings b. Net savings if interest rates rise to 11 percent Net savings if interest rates fall to 3 percent c. Net savings if interest rates rise to 11 percent Net savings if they fall to 3 percent

Answer 1

Part A

Premium for purchasing the cap = 0.0075 x $202 million = $1,515,000. If interest rates riseto 10 percent, cap purchasers receive $202 million x 0.01 = $2,020,000. The net savings is $505,000 (2020000-1515000)

Part B

If the FI also purchases the floor: Premium = 0.0080 x $202 million = $1,616,000, and the total premium = $1,616,000 + $1,515,000 = $3131000

If interest rates rise to 11 percent, the cap purchaser receives 0.02 x $202 million = $4,040,000, and the net savings = $4,040,000 - $3131000 = $909,000.

If interest rates fall to 3.2 percent, the floor purchaser receives 0.01 x $202 million = $2,020,000, and the net savings = $2,020,000 - $3,131,000 = -$1,111,000.

Part C

If the FI sells the floor, it receives net $1,616,000 - the cost of the cap of $1,515,000 =+$101,000.

If interest rates rise to 11 percent, cap purchasers receive 0.02 x $202m = $4,040,000. The net the net savings = $4,040,000 + $101,000 = $4,141,000.

If interest rates fall to 3.2 percent, floor purchasers receive 0.01 x $202 million = $2,020,000.The net savings to the FI = $-2,020,000 + 101,000 = -$1,919,000.

A	amount received	2020000
	Net savings	505000
B	Net savings if interest rates rise to 11 percent	909000
	Net savings if interest rates fall to 3 percent	-1111000
C	Net savings if interest rates rise to 11 percent Net savings if interest rates fall to 3 percent	4141000 -1919000